UPSC Prelims 2013 Q43: Indian Economy – Monetary Policy & Money Supply
An increase in the Bank Rate generally indicates that the
- (a) market rate of interest is likely to fall
- (b) Central Bank is no longer making loans to commercial banks
- (c) Central Bank is following an easy - money policy
- (d) Central Bank is following a tight - money policy
Answer: (d) Central Bank is following a tight - money policy
Explanation
Increase in the Bank Rate
The Bank Rate is the rate at which the RBI lends long-term funds to banks.
Raising it makes borrowing costlier, so money becomes 'tight'.
| Option | Verdict | Reason |
|---|---|---|
| (a) Market rate of interest is likely to fall | Incorrect | Market rates rise |
| (b) Central Bank is no longer making loans to commercial banks | Incorrect | It still lends, at a higher rate |
| (c) Central Bank is following an easy-money policy | Incorrect | The opposite |
| (d) Central Bank is following a tight-money policy | Correct | Costlier credit, less money supply |
The two policies:
| Policy | Rates | Aim |
|---|---|---|
| Tight (dear) money | Raised | Control inflation |
| Easy (cheap) money | Lowered | Boost growth |
Today the repo rate is the main policy rate; the Bank Rate is used mainly to fix penalties on banks.
Answer: (d) Central Bank is following a tight-money policy.
Why each option is right or wrong
- (a) Incorrect. A higher Bank Rate pushes market interest rates up, not down.
- (b) Incorrect. The Central Bank continues to lend, only at a higher cost.
- (c) Incorrect. An easy-money policy means lower rates.
- (d) CORRECT. A rise in the Bank Rate signals a tight-money policy.
Key point
Higher Bank Rate = tight (dear) money policy: costlier credit, lower money supply, used against inflation.
Remember
Bank Rate up = tight money.
Common mistakes
- Mixing up tight and easy money.
- Confusing the Bank Rate with the repo rate.
- Thinking a higher rate means the RBI has stopped lending.
Exam tip
Rates up = tight money. Rates down = easy money.
Sources
- Reserve Bank of India — Monetary Policy: instruments
- NCERT Class XII — Introductory Macroeconomics, Ch 3 (Money and Banking)