Functions and Importance of Money Market

The money market performs several functions that keep the wider financial system, and the economy built on top of it, running smoothly:

• Provides short-term liquidity to businesses and government — a company facing a temporary cash shortfall (say, to pay suppliers before its own customers pay it) can raise short-term funds through instruments like commercial paper or commercial bills, without having to disturb its long-term capital structure. Similarly, the Government of India meets its short-term cash-flow needs mainly through Treasury Bills.
• Helps the RBI implement monetary policy — the RBI uses the money market as the channel through which it injects or withdraws liquidity from the banking system, most directly through repo and reverse repo operations (see Section 4). Changes here ripple through to interest rates across the wider economy, which is exactly how the RBI's monetary-policy decisions get transmitted in practice.
• Provides a channel for banks to manage day-to-day liquidity — a bank that finds itself short of funds on a particular day (perhaps because of an unexpected outflow) can borrow overnight from another bank with a temporary surplus, through the call money market, rather than being forced into a liquidity crisis.
• Helps equilibrate the demand and supply of short-term funds — by bringing together those who have temporary surplus cash (looking for a safe, short-term return) and those who have a temporary shortage (looking to borrow briefly), the money market ensures short-term funds flow to where they are needed instead of sitting idle in one place while another place goes short.
• Enables non-inflationary financing of government requirements — by allowing the Government to raise short-term funds through Treasury Bills rather than simply printing new money to meet a temporary cash gap, the money market helps keep government short-term financing from directly adding to inflationary pressure. …