Finance Professional
230 Points
Joined June 2010
When the RBI increases the lending rate (rate at which it lends to banks), it becomes costlier for banks to borrow from RBI. Hence:-
-- banks' borrowing from RBI is reduced
--availability of credit is less
--money supply in the economy is reduced, resulting in lesser aggregate demand and lower prices.
Similarly, when the RBI increases the CRR, the banks are required to keep higher amount of their deposits with the RBI. Thus the funds available with them for lending to public reduces, resulting in lower money supply, lower demand and lower prices.