Question

Explain the role of reverse repo rate in controlling money supply.

Answer 1

Reverse repo rate is the rate at which RBI borrows money from other commercial banks. RBI makes use of this tool when it feels that there is exess money supply in the banking system. An increase in the reserve repo rate implies that the banks will get a higher rate of interest from the RBI on their lendings. This induces the banks to transfer more funds and lend more to the RBI due to attractive interest rates, thereby reducing money supply in the economy.