Question

On May 22, 2020, the RBI reduced the policy repo rate by 40 bps (100 bps = 1 per cent), from 4.4 per cent to 4 per cent. The Marginal Standing Facility (MSF) rate was
reduced to 4.25 per cent and reverse repo rate to 3.35 per cent.
i) Explain why the inter-bank interest rate (the call money rate) typically stays inside the
above corridor of policy rates, i.e. the call money rate does not go beyond the MSF rate and
does not fall below the reverse repo rate.
ii) Explain (using appropriate graphs) the effects of an increase in CRR on (1) money supply/
money demand, (2) investment expenditure, (3) GDP & price level.

Answer 1

1) RBI reduced the repo rate by 40 bps because in this crucial time economy need managed money flow in the market so that this reduction helps to improve the condition of the market.

Inter-bank interest rate corridor is a system for short tern market interest rates towards the RBI target rate. on this rate RBI lends to banks annd set a deposite rate to take deposits. call money does not go beyond the MSF rate because it is a overnight basis and it belongs to SLR of the bank.

2)the higher the CRR the lower is the liquidity. CRR directly effects the interest rates higher the CRR higher interest rate and banks doesn't have enough money to sanction loans. DEMAND FOR MONEY graph is for this point.

Investmennt expenditure effects inverse by the CRR . If CRR increase then the investment declines and also reduced the supply of money. And also impacted the growth of economy NEGATIVELY.

CRR is not directly related to GDP but it is related to money supplyn so that when money supply increases in the market then it will stable the GDP and reduce the INFLATION in the market.