Well, It is not about the interest rate at which banks offer you loans it does matter to this article though, but it is about the interest rate at which RBI lends money to the banks, ok ok I can sense some confusion and you won’t be at the end.
In this walth post, You will learn about how the Reserve Bank of India or RBI’s interest rate i.e, repo rate affects the inflation or price of goods you buy, and what is repo rate in the first place? this article has the answers.
Inflation is basically an increase in the price of goods. Why does the price of goods increase in the first place?
Let’s understand it with an example
It is a demand and supply thing. In an economy, there are 20,000 products and the total money supply in the economy is 20,000 rupees. So, the average price of a single product is 1rupees(20,000 / 20,000 = 1). let this be the first case.
The second case has the same 20,000 goods but the total money supply in the economy is 40,000 rupees, now the average price of the product will be 2 rupees (40,000 / 20,000 = 2)
that’s a 100% increase and this increase in percentage is called as inflation.
When more money chases few goods the price increas.
That was a short into about inflation, Make sure to check out the post about inflation.
Money, Banks and repo Rate
This is something interesting to know about. Well, we all know that the RBI prints money in India and we use rupees for traction here in India. You might have earned the money you own from an employer or profits from a business if you own one. Now, you use the money have to buy goods and services for your needs, as you spent the money and it reached someone else in exchange for the value they provide. Hence your spending is someone’s income. And inturn their spending is someone else’s incomeSuchtransactionshelp run the economy.
Now, there are two ways you can get money 1st is, you provide value to the market place and in return you earn money. It can your job(your provide work(value) and get paid), StartUp(solves’ people’s problem and get paid), side hustle and even selling some products in a market. Provide more value earn more money.
And the 2nd way is to borrow money from a bank with some interest rate and banks borrow money from RBI at an interest rate called repo rate. So, if the repo rate is lower banks will borrow money from RBI at a lower price and lend it to you at a lower interest rate.
RBI influence
When the interest rates are low, you don’t have to pay much money as an interest to the bank, and more people will be ready to get a loan from the bank. And when more and more people borrow loans the money supply in the economy increase, remember earlier example where I told: “ when more money chases fewer goods the price of goods increases” and thus Low repo rate increase inflation.
The other way around is also true. When RBI increases the repo rate, it will lend money to banks at a higher rate and as a result, banks will lend money to people at a higher interest rate. so, if the interest rates are higher, only a few people will be ready to take the loan and hence less money flow in the economy and Inflaion will decrease.
In fact RBI uses repo rate as a tool to control inflation.
Well, now as you learned about relation between repo rate and inflation. How can you usethe situation to you advantage? here is a tip. Try to pay off your debts when RBI reduces the repo rate.
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Originally published at https://www.walth.org on February 12, 2021.
