In November 2008, the Reserve Bank of India RBI) lowered its ʺrepoʺ rate, the rate at which it lends to banks, from 8 percent to 7.5 percent. Only two weeks earlier, it had lowered the rate from 9 percent to 8 percent.
The Economist, 11/6/2008
In its attempt to change real GDP, which of following sequences correctly describes the transmission of RBIʹs monetary policy?
i. the real interest rate falls
ii. the money supply increases
iii. bank reserves increase
iv. supply of loanable funds increases
v. aggregate demand increases

Question

Quizplus · Accepted Answer

The correct sequence for the transmission of RBI's monetary policy is as follows:
- First, the RBI lowers its repo rate (the rate at which it lends to banks), as mentioned in the article.
- This leads to an increase in bank reserves (iii) as banks borrow more from the RBI.
- With more reserves, banks can lend more, increasing the supply of loanable funds (iv).
- As the supply of loanable funds increases, the real interest rate (i.e. adjusted for inflation) falls (i).
- Lower interest rates make borrowing cheaper, leading to an increase in the money supply (ii).
- Finally, with more money available for investment and consumption, aggregate demand increases (v). 
Thus, the correct sequence is iii, ii, iv, i, and v, which is only found in choice D.

In November 2008, the Reserve Bank of India RBI) Lowered