Answer:
Under open market operations, RBI purchases or sells government securities to general public for the purpose of increasing or decreasing the stock of money in an economy. The purchase or sale of securities controls the money in the hands of public as they deposit or withdraw the money from commercial banks Thus, money creation by commercial banks get affected. Suppose, the Central Bank purchase securities of Rs.1,000 from a bond holder by issuing a cheque. The seller of the bond produces this cheque of Rs.1,000 to his commercial bank. The commercial bank credits the account of the seller by Rs.1,000 and the deposits of the bank goes up by Rs.1,000, which is a liability for the bank. On the other hand, the assets of the commercial bank also goes up as the cheque in its possession is a claim on the Central Bank. Thus, purchase of security increases the money creation of commercial banks and similarly sale of securities decreases the credit creation of commercial banks. Thus, the Central Bank controls the process of money creation by commercial banks through open market operations.
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