UPSC Prelims 2011 Q88: Indian Economy – Monetary Policy & Money Supply
The lowering of Bank Rate by the Reserve Bank of India leads to
- (a) More liquidity in the market
- (b) Less liquidity in the market
- (c) No change in the liquidity in the market
- (d) Mobilization of more deposits by commercial banks
Answer: (a) More liquidity in the market
Explanation
Lowering of the Bank Rate
The Bank Rate is the rate at which the RBI lends to commercial banks for the long term, without security.
What happens when it is lowered:
| Step | Effect |
|---|---|
| 1 | Banks can borrow more cheaply from the RBI |
| 2 | Banks lower their own lending rates |
| 3 | People and firms borrow more |
| 4 | More money flows in the market |
The options checked:
| Option | Verdict | Reason |
|---|---|---|
| (a) More liquidity in the market | Correct | Cheaper credit expands money in circulation |
| (b) Less liquidity in the market | Incorrect | That follows a rise in the Bank Rate |
| (c) No change in the liquidity in the market | Incorrect | The rate does affect credit |
| (d) Mobilization of more deposits by commercial banks | Incorrect | Lower rates make deposits less attractive |
Related rates:
| Rate | Meaning |
|---|---|
| Repo rate | RBI lends to banks short-term against securities; the main policy rate today |
| Reverse repo rate | RBI borrows from banks |
| Marginal Standing Facility | Emergency overnight borrowing; the Bank Rate is now kept equal to it |
Answer: (a) More liquidity in the market.
Why each option is right or wrong
- (a) CORRECT. A lower Bank Rate makes credit cheaper and brings more liquidity.
- (b) Incorrect. Less liquidity results when the Bank Rate is raised, not lowered.
- (c) Incorrect. A change in the Bank Rate does change liquidity.
- (d) Incorrect. Lower rates do not help banks in mobilization of more deposits.
Key point
Bank Rate down: cheaper borrowing, more credit, more liquidity (expansionary). Bank Rate up: dearer credit, less liquidity (to fight inflation). Repo rate is the main policy rate.
Remember
Bank Rate down = liquidity up.
Common mistakes
- Reversing the link: thinking a lower rate tightens money.
- Confusing the Bank Rate with the repo rate, which needs securities.
- Assuming lower rates bring banks more deposits.
Exam tip
Cheaper money means more money. Any cut in an RBI lending rate adds liquidity.
Sources
- Reserve Bank of India — Monetary Policy: Instruments (Bank Rate, Repo Rate, Marginal Standing Facility)
- NCERT Class XII — Introductory Macroeconomics, Ch 3 (Money and Banking)