The correct option is Actions to neutralize the impact of external shocks on the money supply..
Explanation
Sterilisation refers to the operations conducted by a Central Bank (such as the Reserve Bank of India) to neutralize the impact of its foreign exchange market interventions on the domestic money supply. Its primary objective is to insulate the domestic economy from the monetary effects of external capital flows.
Detailed Analysis:
- Disinfecting currency notes to prevent disease spread. is incorrect: This is a literal interpretation unrelated to monetary policy or economics.
- The process of demonetising high-value currency notes. is incorrect: This describes Demonetisation, which involves stripping a currency unit of its status as legal tender.
- Actions to neutralize the impact of external shocks on the money supply. is correct: When the Central Bank intervenes in the foreign exchange market (e.g., buying foreign currency to prevent currency appreciation), it injects domestic currency into the economy, increasing the money supply. To prevent this excess liquidity from causing inflation, the Central Bank "sterilises" the intervention by selling Government Securities (G-Secs) through Open Market Operations (OMOs). This absorbs the excess liquidity, keeping the monetary base stable.
- Setting the interest rate to zero. is incorrect: This refers to a Zero Interest Rate Policy (ZIRP), a tool used to stimulate economic activity, distinct from sterilisation operations.
Key Takeaway: Sterilisation is the mechanism used to offset the expansionary or contractionary effects of foreign exchange interventions on the domestic money supply, typically executed via Open Market Operations (OMOs).