Question

How do changes in Bank Rate affect money supply in an economy? Explain.

Answer 1

The rate at which commercial banks can borrow money from RBI, when they run short of reserves, is called bank rate. When the Central Bank increases the bank rate, it increases the cost of borrowing and hence, discourages the borrowers from taking a loan. Due to this, the process of credit creation and flow of money also reduces.

On the other hand, when the Central Bank decreases the bank rate, it encourages the borrower to take more and more loans. High demand for loans increases the credit multiplier and credit creation process of commercial banks.