Question

“Repo Rate and Bank Rate are two different measures, but a change in either of them may have the similar implication on the money supply in an economy.”

Defend or refute the given statement, giving valid explanation in support of your answer.

Hint:

Defend the statement. Both rates are the cost at which the Central Bank lends to banks, so a fall in either makes credit cheaper and raises the money supply, and a rise does the opposite.

Answer 1

Step 1: State the stand:
The statement is defended. Repo Rate and Bank Rate are different measures, but a change in either has the similar effect on the money supply.

Step 2: Meaning of the two rates:
Repo Rate is the rate at which the Central Bank (RBI) lends money to commercial banks for a short period, against government securities, with an agreement to buy them back.
Bank Rate is the rate at which the Central Bank lends to commercial banks for a long period, without any such repurchase agreement.
Both are rates at which the Central Bank lends to commercial banks. The key difference lies in short-term and long-term needs.

Step 3: Effect of a fall in either rate:
When the Central Bank lowers the Repo Rate or the Bank Rate, borrowing from it becomes cheaper for commercial banks.
Banks then lower their own lending rates. Credit becomes more affordable for the public.
People and firms borrow more, so the money supply rises.

Step 4: Effect of a rise in either rate:
When the Central Bank raises either rate, borrowing from it becomes costlier for banks.
Banks raise their lending rates. Loans become dearer and borrowing falls, so the money supply falls.

Step 5: Conclusion:
A rise in either rate cuts the money supply, and a fall in either rate raises it. The direction of effect is the same, so the statement is correct.

Final Answer:
The statement is defended. Both Repo Rate and Bank Rate are rates at which the Central Bank lends to commercial banks, so a fall in either rate raises the money supply and a rise in either rate lowers it.