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CMA Foundation · Fundamentals of Business Economics and Management · Money and Banking

The economy faces high inflation driven by excess demand. The RBI raises the repo rate and also conducts sales of government securities through open market operations. Which combination of effects is expected?

Borrowing costs rise, liquidity falls and credit growth slows. A higher repo rate makes funds costlier for banks, and selling government securities drains cash from the banking system. Both are tight monetary policy tools used to curb demand-driven inflation.

  1. ABank borrowing costs rise, system liquidity falls, and credit growth slowsCorrect
  2. BBank borrowing costs fall, system liquidity rises, and credit growth speeds up
  3. CBank borrowing costs rise, system liquidity rises, and credit growth speeds up
  4. DBank borrowing costs fall, system liquidity falls, and credit growth slows

Explanation

A higher repo rate makes borrowing from the RBI costlier, which pushes up lending rates. Selling securities in the market absorbs bank reserves, reducing liquidity. Both are contractionary measures, so credit growth and demand slow. The other options mix expansionary and contractionary effects inconsistently.

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