Evey free economy's monetary & bank's policy is regulated by the central bank of that economy.Central bank controls the demand and supply of the money in the market through the increase or decrease in the various policy instruments such as CRR ,SLR, Bank rates etc.Central Bank uses various policy instrument to bring forth a healthy reserve deposit ratio in commercial banks.
Cash Reserve Ratio which specifies the fraction of deposits that banks must keep with the central bank.
Statuary Liquidity ratio which require the bank to maintain a give fraction of their total demand and time deposit in the form of specified liquid assets with the central bank.
Bank Rate is the rate at which commercial banks can borrow money from central bank of the country when they run short of reserves.A high bank rate makes such borrowing costly and in effect,encourages the commercial banks to maintain a healthy Reserve Deposit Ratio.
If the central bank wants to control the supply of money in the market then it increases the rates.It also increases the rates when the inflation of the country increases.The increased money supply may not altogether be good for the economy's health. If the volume of goods and services produced in the economy remains unchanged,then the extra money will lead to increase in prices of all commodities.And at that time when people have more money with them then they will compete with each other in the commodities market for buying the same old stock of goods.
So, the central bank plays a very important role to maintain the equality in the economy.
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