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      Question

      An increase in the Repo Rate by the Reserve Bank of

      India is likely to have the following impacts on the economy?  1. Increase in the cost of borrowing for commercial banks.  2. Decrease in the lending rates offered by commercial banks  3. Potential decrease in aggregate demand.  4. Increased incentive for commercial banks to borrow from the RBI.  Select the correct answer using the codes below: 
      A 1 and 2 only Correct Answer Incorrect Answer
      B 2 and 4 only Correct Answer Incorrect Answer
      C 1 and 3 only Correct Answer Incorrect Answer
      D 3 and 4 only Correct Answer Incorrect Answer

      Solution

      Repo Rate: The Repo Rate is the interest rate at which the RBI lends short-term funds to commercial banks, against government securities as collateral. It helps in controlling short-term liquidity in the financial system.  Statement 1 is correct: A higher repo rate makes borrowing costlier for commercial banks.  Statement 2 is not correct: Lending rates are likely to increase, not decrease.  Statement 3 is correct: Higher interest rates tend to reduce borrowing and spending, which can reduce aggregate demand.  Statement 4 is not correct: A higher repo rate discourages banks from borrowing due to increased cost.

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