Read the following information carefully : "The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), recently increased the Repo Rate by 50 basis points. The Rate stands today at 5.40%, whereas Reverse Repo Rate was left unchanged at 3.35%." Answer the following questions : (i) Identify the nature of the two monetary policy measures mentioned in the above text. (ii) Elaborate the likely economic rationale behind the increase in Repo Rate by the Monetary Policy Committee. Suppose an imaginary economy is facing a situation of deficient demand in the short run time period. Discuss briefly, the probable impacts of the same on the economy.

Question

Accepted Answer

Based on the information about MPC increasing Repo Rate by 50 basis points to 5.40%:

1. This is a contractionary monetary policy measure
2. Aimed at controlling inflation in the economy
3. Increase in Repo Rate increases cost of borrowing for banks
4. Banks will raise their lending rates
5. Borrowing becomes expensive
6. Consumption and investment decrease
7. Aggregate demand falls
8. Money supply decreases
9. Inflationary pressure is controlled

The 50 basis points increase is significant and indicates the central bank's commitment to controlling inflation. This will have a transmission effect on the entire economy through higher interest rates.