CURRENT REPO VS [NEUTRAL OR TERMINAL] REPO RATE

Question 1

What is the repo rate?

Answer 1

The repo rate is the interest rate charged by the central bank (like the Reserve Bank of India) when it lends money to commercial banks on a short-term basis.

Question 2

Explain the concept of the neutral repo rate (or terminal repo rate).

Answer 2

The neutral or terminal repo rate is a theoretical level where the repo rate maintains price stability (controls inflation) and supports full employment. The central bank wouldn’t increase the repo rate above this level as it could harm economic growth.

Question 3

What is NAIRU? How does it differ from the repo rate?

Answer 3

NAIRU stands for the Non-Accelerating Inflation Rate of Unemployment. It’s the theoretical level of unemployment where inflation remains stable. NAIRU is a measure of unemployment, while the repo rate is an interest rate tool used by central banks.

Question 4

Why is the terminal repo rate considered a theoretical concept?

Answer 4

The terminal repo rate is theoretical because it represents an ideal balance between inflation and employment. This balance is difficult to pinpoint in a real-world economy, and the conditions that determine it can change over time.

Question 5

What could be the consequences of increasing the repo rate above the terminal repo rate?

Answer 5

Increasing the repo rate above the terminal level could:
Make borrowing more expensive, causing a slowdown in economic activity.
Lead to reduced consumer spending.
Potentially increase unemployment.