When the Reserve Bank of India (RBI) increases the Repo Rate during an inflationary period… — State PSC Exam

When the Reserve Bank of India (RBI) increases the Repo Rate during an inflationary period, which of the following outcomes is primarily expected in the economy?

Borrowing becomes more expensive for commercial banks, leading to a reduction in market liquidity and curbing inflation.Answer
B
Borrowing costs for commercial banks decrease, encouraging higher loan disbursement to consumers.
C
Commercial banks immediately lower their interest rates on retail loans to attract new borrowers.
D
Liquidity within the banking system expands rapidly, causing a surge in aggregate consumer demand.

Answer

Borrowing becomes more expensive for commercial banks, leading to a reduction in market liquidity and curbing inflation.

The correct answer correctly states that raising the Repo Rate increases borrowing costs for commercial banks, leading to higher lending rates across the banking system. This curbs credit expansion, contracts market liquidity, and helps control inflation.

Step-by-Step Solution

Identify the nature of Repo Rate

Repo Rate is the interest rate at which commercial banks borrow short-term funds from the RBI against government securities.

Understanding the definition helps determine how rate changes impact commercial bank costs.

Analyze the impact of an increase in Repo Rate

A higher Repo Rate increases the cost of borrowing for commercial banks from the RBI.

Commercial banks pass on these higher costs to their customers by raising lending interest rates.

Determine the macroeconomic outcome on liquidity and inflation

Higher loan rates discourage borrowing and spending, which contracts liquidity in the economy and reduces inflationary pressure.

Tightening liquidity suppresses excess aggregate demand, helping stabilize prices.

Key Concept

Repo Rate Impact on Money Supply and Inflation Control

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