Question

increase in repo rate controls inflation. justify the statement. (need 500-600 words with figure if possible)

Answer 1

Inflation is the situation of a rise in the average prices of the economy. This happens when there is a lot of money flowing in the economy and people have a lot of money in their hands. A lot of money in the hands of people increases the aggregate demand in the economy and that leads to a rise in the average price level and we call it inflation.

Repo rate is the rate at which the central bank lends money to the commercial banks or it is the rate at which the commercial bank borrows money from the central bank. When there is inflation in the economy, the only way to control it is to decrease the money supply in the economy, which leaves people with less money in their hands, and that leads to a decrease in aggregate demand and inflation.

The central bank uses the repo rate to control inflation. The central bank increases the repo rate. This means the cost of borrowing money by commercial banks from the central bank becomes increases. When this happens, the borrowings from the central bank decreases. When commercial banks borrow less then even they are left with limited money supply to further lend to people and they raise their interest rates too. An increase in interest rates discourages investments in the economy, increases savings and decreases consumption level.

Ultimately the money supply in the economy decreases as a result of a decrease in investments and consumption levels. Thus, the increase in repo rate controls inflation.