Question

Read the following text carefully:
“The Reserve Bank of India (RBI) announced a 50 basis point Repo Rate cut to 5.50% from 6%.”
In the light of the given text and common understanding, answer the following questions:

• [(i)] Identify the economic issue indicated in the above text.
• [(ii)] Explain the likely causes and consequences of this step of RBI on the economy.

Hint:

Repo rate ↓ → Loans cheaper → Demand ↑ → Growth ↑

Answer 1

Step 1: Understanding the Concept:
The Repo Rate is the rate at which the Central Bank lends money to commercial banks. It is a quantitative tool of monetary policy.
Step 2: Detailed Explanation:
(i) Economic Issue:
A cut in the repo rate is a "cheap money policy" usually adopted when the economy is facing Deficient Demand, Recession, or Economic Slowdown. The goal is to boost Aggregate Demand.

(ii) Causes and Consequences:
1. Cause: The RBI wants to inject liquidity into the system to encourage borrowing and spending to fight deflationary pressures.
2. Mechanism/Consequence:
- Lower Interest Rates: When RBI cuts Repo Rate, commercial banks' cost of borrowing falls. They pass this benefit to customers by lowering lending rates (EMI becomes cheaper).
- Rise in Credit Demand: Cheaper loans encourage households to buy houses/cars and firms to invest in new projects.
- Rise in AD: Increased consumption and investment lead to a rise in Aggregate Demand.
- Growth: Higher demand leads to higher production and employment, helping the economy recover from a slowdown.
Step 3: Final Answer:
The issue is deficient demand. The consequence is an increase in money supply and aggregate demand due to cheaper credit.