Question

Explain the likely cause behind the step taken by the Reserve Bank of India (RBI).

Answer 1

Step 1: Understand the step taken by RBI:
The text says that the RBI reduced the Cash Reserve Ratio (CRR) by 100 basis points, that is, by 1 percentage point.
CRR is the share of the total deposits of a bank that it must keep with the RBI in cash. Banks cannot lend this part.

Step 2: Read the aim given in the text:
The text says the aim is to "improve the growth momentum by stimulating domestic private consumption and investment".
So the RBI wants people to spend more and firms to invest more.

Step 3: Find the likely cause:
A central bank tries to raise spending only when spending is too low. It means that aggregate demand is less than what the economy can produce.
This situation is called deficient demand. Prices may then fall or stay weak, which is the risk of deflation.
Output and jobs also slow down when demand is deficient, and this hurts the growth of the economy.

Step 4: Link the cause to the CRR cut:
A lower CRR leaves more money with banks to lend. Loans become easier to get, so households and firms can spend and invest more.
Hence the cut is a remedy for weak private demand.

Final Answer:
The RBI cut the CRR because private consumption and investment were weak. The economy faced deficient demand (a risk of deflation), and the RBI wanted to revive demand and growth.
\[ \boxed{\text{Cause = deficient demand, to be corrected by raising private consumption and investment}} \]

Answer 2

Step 1: Recall what CRR does:
Cash Reserve Ratio is the part of its deposits that a commercial bank must keep with the RBI. The bank cannot lend this part.
The text says the RBI cut this ratio by 1 percentage point.

Step 2: Effect on banks:
A lower CRR frees some money. On deposits of Rs. 100 crore, banks now keep Rs. 1 crore less with the RBI.
This extra money raises the lending capacity of commercial banks.

Step 3: Effect on money supply and spending:
Banks lend more, and credit becomes cheaper and easier to get. The money supply in the economy increases.
Households borrow to buy goods, and firms borrow to invest. So consumption (C) and investment (I) rise.

Step 4: Effect on Aggregate Demand:
Aggregate demand is the total planned spending, and it includes C and I. When both rise, AD shifts upward.
A higher AD helps the economy to come out of deficient demand.

Final Answer:
A cut in CRR gives banks more funds to lend, increases the money supply and raises consumption and investment, so Aggregate Demand increases.
\[ \boxed{\text{CRR} \downarrow \Rightarrow \text{lending} \uparrow \Rightarrow \text{money supply} \uparrow \Rightarrow \text{AD} \uparrow} \]