Simply speaking, the government borrows money from RBI. RBI and the government are two different entities in Indian economy that create and operate money in India. Whenever the government needs money, it pledges either gold or government securities with RBI and RBI prints it. The government obviously cannot borrow unlimited amount of money from RBI due to the fear of inflation. Lets examine how this inflation gets created.
Imagine on day 1. There are no assets and no money in the system. There are only two entities RBI on one side and the Government on the other. The government pledges some gold(or some asset) that is available in India and requests RBI to print money. RBI prints the money and hands it over to GOI.
GOI uses this money to build more mines, improve agriculture and build dams. In the process, it also transfers money into the hands of the people. This creates demand for food and generates employment. Small businesses spring up to cater to the basic food needs. Money flows to and fro between food producers and workers. As the food needs are met, people think of comfort and luxury. There is now an opportunity to create a new industry that will service these new needs, but there is no money to create one. All the money in the system is disbursed among the people. The people spend part of the money, save some of it and hold some it in their hands. It means money is held by people in little fragments and cannot be pooled readily for new investments. That's when GOI should returns to RBI for new money.
On the contrary, if GOI just blew away the money in some bizzare unproductive fashoin like some arrogant dictator using governement money for personal purposes, then the money is not distributed among the people. It is concentrated only in a few hands. Food and material supply side is pathetic and most people have no money. But competition for meagre resources is fierce. This results in runaway.
Imagine on day 1. There are no assets and no money in the system. There are only two entities RBI on one side and the Government on the other. The government pledges some gold(or some asset) that is available in India and requests RBI to print money. RBI prints the money and hands it over to GOI.
GOI uses this money to build more mines, improve agriculture and build dams. In the process, it also transfers money into the hands of the people. This creates demand for food and generates employment. Small businesses spring up to cater to the basic food needs. Money flows to and fro between food producers and workers. As the food needs are met, people think of comfort and luxury. There is now an opportunity to create a new industry that will service these new needs, but there is no money to create one. All the money in the system is disbursed among the people. The people spend part of the money, save some of it and hold some it in their hands. It means money is held by people in little fragments and cannot be pooled readily for new investments. That's when GOI should returns to RBI for new money.
On the contrary, if GOI just blew away the money in some bizzare unproductive fashoin like some arrogant dictator using governement money for personal purposes, then the money is not distributed among the people. It is concentrated only in a few hands. Food and material supply side is pathetic and most people have no money. But competition for meagre resources is fierce. This results in runaway.
The moral of the story is, GOI should borrow from RBI only if
i. GOI has created enough capital assets to ensure sufficient food and material supply and
ii. GOI has ensured that money is not concentrated with a bunch of feudal lords.
Comments