Effect of RBI decision to reduce Interest rate

Effect of RBI decision to reduce Interest rate 

It was really exciting news for every common man when RBI Governor Raghuram Rajan announced to reduce the key interest rate by 50 basis points from 7.25 % to 6.25 %. Everyone was saying thank you, thank you, thank you and they took this as a Diwali Bonus as earlier said by RBI Governor. But, no one have any idea about the real reason behind this interest rate reduction and how this reduction going to help anyone.

I know you are wondering why I mentioned that no one had idea about how this reduction going to help them because this reduction is from the RBI to the banks; now it tonally depends upon bank how to deal with this reduction and how to pass benefit to common man. Let’s go through an anecdote to completely understand this philosophy and what does interest rate deduction mean to common person?

A short anecdote to completely understand financial system of reduction of interest rate

Assume finance system as a River and RBI is the Head of this river and Only RBI has the right to decide when and how much water is to pass and it totally depends upon the how much water they are getting in rivers. If they keep passing water continuously, it could lead to destruction and in case of passing less water, Water scarcity could happened and everyone would remain starve in this case.

So, same concept applies to money flow in the market. If there would be too much money in the market, People will consume more; borrow more with less interest which would automatically increase in prices of items that’s also increases inflation. On the other side, if there would be less money in the market; No one will consume; No increases in any item demand which drastically increases unemployment also. This is known as deflation.

As this time, people are not spending more and unemployment is on the top; so they decided to reduce interest rate so that people can buy more, consume more which would automatically increase unemployment also.

Now, some of you wondering why don’t RBI reduce too much interest rate; it is because people would spend excessively and lavishly; which would increase inflation. So, RBI took this keen step to improve India’s economy.

Now, it is totally depends upon Banks how they pass this reduction; how much time lag would be in between. These things also effect economy. Stay with us for more interesting articles like this.

 

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