In November 2008, the Reserve Bank of India (RBI) lowered its "repo" 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 RBI's 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 starts with an increase in bank reserves (III) as the central bank lends more to banks at a lower rate. This leads to an increase in the money supply (II), which then causes the supply of loanable funds to increase (IV). With more funds available for lending, the real interest rate falls (I), making borrowing cheaper. This encourages investment and consumption, leading to an increase in aggregate demand (V).

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