In the coming few weeks, we will be focusing on these basic things such ascash reserve ratio (CRR), repo rate, reverse repo rate and how we can use all of these to make better investment decisions when investments in a debt mutual fund. Here we go...
RBI uses interest rates to keep economy on track, which means controlling inflation and at the same time ensuring growth. To keep inflation under check, it is important to control money supply. If money in the hands of people increases, people wouldn't mind paying more for things, for which otherwise they would not have paid so much.
Just because they have more money, they will be ready to pay/ spend more. This in turn stokes inflation, which is nothing but general rise in prices. When prices rise, we say inflation is rising.
So to control inflation, it is necessary that money supply in the economy should be controlled. Thus if inflation rises, RBI hikes key interest rates (CRR & repo) so that money supply in the system reduces. When inflation was raging for all of 2008, we saw RBI constantly hiking repo rate & CRR. While we will cover in detail how this affects inflation for the time being it is enough to understand that economic theory suggests that a hike in these rates leads to a fall in inflation.
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