Selling of bonds by the RBI will cause money supply to __________.

The correct option is decrease.

Detailed Explanation:

The Reserve Bank of India (RBI) uses Open Market Operations (OMO)—the buying and selling of government securities (bonds) in the open market—to regulate liquidity and control the money supply in the economy.

When the RBI sells bonds, the following step-by-step process occurs:

1. Outflow of Cash/Reserves: Commercial banks and institutional investors buy these bonds from the RBI by transferring cash from their reserve accounts to the RBI.

2. Reduction in Commercial Bank Reserves: This transaction withdraws money from the banking system, reducing the liquidity and total reserves available with commercial banks.

3. Contraction of Credit Lending: Because banks now hold fewer reserves, their capacity to create credit and extend loans to businesses and individuals is reduced.

4. Decrease in Money Supply: Less loan disbursement leads to reduced economic activity and cash circulation, causing the overall money supply in the economy to decrease.

Conversely, if the RBI wants to increase the money supply, it buys bonds, infusing liquidity back into the banking system.