How does repo rate help in expanding or contracting credit in an economy?
Solution:
The repo rate is the rate at which the central bank lends money to commercial banks in the event of any shortfall of funds. The repo rate is used by monetary authorities to control inflation.
In the event of inflation, central banks increase the repo rate as this acts as a disincentive for banks to borrow from the central bank which in turn decreases the circulation of money in the economy because banks need to pay higher interest rates on the money they borrow from the central bank. This ultimately reduces people's purchasing power and thus helps arrest inflation.
On the contrary, the repo rate is decreased in the event of deflation, which acts as an incentive for banks to borrow from the central bank, increasing the money circulation in the economy because banks need to pay lower interest rates on the money they borrow from the central bank. As a result, the people's purchasing power rises and helps tackle deflation.
The repo rate is the rate at which the central bank lends money to commercial banks in the event of any shortfall of funds. The repo rate is used by monetary authorities to control inflation.
In the event of inflation, central banks increase the repo rate as this acts as a disincentive for banks to borrow from the central bank which in turn decreases the circulation of money in the economy because banks need to pay higher interest rates on the money they borrow from the central bank. This ultimately reduces people's purchasing power and thus helps arrest inflation.
On the contrary, the repo rate is decreased in the event of deflation, which acts as an incentive for banks to borrow from the central bank, increasing the money circulation in the economy because banks need to pay lower interest rates on the money they borrow from the central bank. As a result, the people's purchasing power rises and helps tackle deflation.