IAI Actuarial Core Principles · Business Economics · Business activity, unemployment and inflation
The Reserve Bank of India unexpectedly cuts its policy repo rate during a period of weak demand. Which sequence best describes the effect through aggregate demand for a bank or insurer's business environment?
A cut in the repo rate lowers borrowing costs, encouraging household spending and business investment, and may support exports through a weaker rupee. Aggregate demand shifts right, raising short-run output and the price level, which affects lending volumes and insurance demand.
- ALower borrowing costs raise consumption and investment, shifting AD right and increasing output and the price levelCorrect
- BLower borrowing costs reduce investment, shifting AD left and reducing the price level
- CLower rates shift long-run aggregate supply left, reducing potential output
- DLower rates reduce the money supply, shifting AD left
- Lower rates only affect exports, leaving consumption and investment unchanged
Explanation
A lower policy rate reduces borrowing costs and tends to raise interest-sensitive consumption and investment, and may weaken the rupee to help exports. Aggregate demand shifts right, raising output and prices in the short run. It does not directly cut potential output.
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