revise eco

 

1. Interest Rates: Repo Rate & Bank Rate

Repo Rate

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  • Definition: The rate at which the central bank lends money to commercial banks against securities.
  • Impact on Inflation:
    • To Control Inflation (Hike Repo Rate):
      • Higher repo rate → borrowing becomes more expensive for banks → banks pass on this cost to consumers and businesses through higher interest rates → reduced consumer spending and business investment → lower demand in the economy → helps reduce inflation.
    • To Boost Growth (Cut Repo Rate):
      • Lower repo rate → cheaper borrowing for banks → lower interest rates for loans → increased borrowing and spending → stimulates demand → may lead to inflation if demand exceeds supply.

Bank Rate

  • Definition: The rate at which the central bank lends to commercial banks without repurchase agreements or collateral.
  • Impact on Inflation:
    • Similar to repo rate, but less frequently used. A higher bank rate discourages borrowing and spending, helping to control inflation. A lower bank rate does the opposite.

2. Reserve Requirements: CRR & SLR

Cash Reserve Ratio (CRR)

  • Definition: The percentage of total deposits that banks must keep with the central bank in cash.
  • Impact on Inflation:
    • Increase in CRR:
      • Reduces the amount of money banks can lend → tightens money supply → lowers spending and demand → helps control inflation.
    • Decrease in CRR:
      • Frees up more funds for lending → increases money supply → boosts spending → may raise inflation.

 

 

 

 

 

 

Statutory Liquidity Ratio (SLR)

  • Definition: The minimum percentage of a bank's net demand and time liabilities (NDTL) that must be maintained in liquid assets such as cash, gold, or government securities.
  • Impact on Inflation:
    • Higher SLR:
      • Banks have to hold more funds in non-lendable forms → reduces funds available for loans → lowers money supply → helps reduce inflation.
    • Lower SLR:
      • Frees up funds for lending → increases money supply → can contribute to inflation.

Summary of Effects on Inflation

ToolIncreased Rate/RequirementEffect on Inflation
Repo Rate↑Decreases inflation (tightens credit)
Bank Rate↑Decreases inflation (reduces lending)
CRR↑Decreases inflation (less money to lend)
SLR↑Decreases inflation (less liquidity)

 

Conclusion

Monetary tools like interest rates and reserve requirements are powerful levers to manage inflation:

  • Tight Monetary Policy (high repo, bank rate, CRR, SLR) → combats high inflation.
  • Loose Monetary Policy (low repo, bank rate, CRR, SLR) → stimulates growth but may fuel inflation if overused.

Central banks must carefully balance these tools based on inflation trends, economic growth, and other macroeconomic conditions.



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