Question

For controlling inflation, Bank Rate is

• A. increased
• B. decreased
• C. kept constant
• D. decreased to zero.

Hint:

Think of it this way: \textbf{Inflation is like an overheating engine}. To cool it down, you need to apply the brakes. Increasing the bank rate is like applying the brakes on the economy—it slows down borrowing and spending.

Answer 1

The Correct Option is A

Step 1: Understanding the Concept:
The Bank Rate (or discount rate) is the interest rate at which a nation's central bank (like the Reserve Bank of India) lends money to commercial banks. It is a key tool of monetary policy used to manage the money supply, control credit, and stabilize prices. Inflation refers to a sustained increase in the general price level of goods and services in an economy.
Step 2: Detailed Explanation:
To control high inflation, the central bank aims to reduce the money supply and curb spending in the economy. This is achieved through a contractionary (or tight) monetary policy.
- The central bank increases the Bank Rate.
- This makes borrowing from the central bank more expensive for commercial banks.
- Commercial banks, in turn, increase their own lending rates for loans to businesses and individuals.
- Higher borrowing costs discourage spending and investment, reducing the overall demand for goods and services.
- This reduction in demand helps to slow down the rate at which prices are rising, thereby controlling inflation.
Conversely, to combat a recession, the central bank would decrease the bank rate to encourage spending.
Step 3: Final Answer:
To control inflation, the central bank increases the Bank Rate. The correct option is (A).