Q.Refer the given image carefully : [Figure: A balance scale titled “Value of Money” — the ‘General Price level’ side is shown rising (up arrows) while the ‘Value of Money’ side is shown falling (down arrows), depicting inflation / a rising general price level.] Explain any two measures that can be taken by the Central Bank to control the indicated macroeconomic problem.

The diagram shows a rising general price level (inflation), where the value of money falls as prices climb. The Central Bank combats inflation by reducing aggregate demand through contractionary monetary policy.

Two key measures:

1. Increase in the Bank Rate

The bank rate is the rate at which the Central Bank lends to commercial banks. When the Central Bank raises this rate, borrowing becomes costlier for commercial banks, who in turn raise their lending rates to the public. Higher interest rates discourage consumer borrowing and investment spending, reducing aggregate demand and cooling inflationary pressure.

2. Sale of Securities (Open Market Operations) …

The balance scale depicts the inverse relationship between the general price level and the value of money. When prices rise across the economy—inflation—each rupee buys fewer goods and services, so the purchasing power (value) of money falls. This is the macroeconomic problem the Central Bank must address.

Central banks use monetary policy to influence aggregate demand and thereby control inflation. The logic is straightforward: inflation often stems from excess demand in the economy (too much money chasing too few goods). By tightening the money supply or making credit more expensive, the Central Bank can dampen spending, cool demand, and bring prices under control.

Here are two key measures:

1. Raising the Repo Rate (Bank Rate)

The repo rate is the interest rate at which the Central Bank lends short-term funds to commercial banks. When the Central Bank raises this rate, borrowing from the central bank becomes costlier for commercial banks. They pass on this higher cost to their customers—households and firms—by raising lending rates on loans (home loans, business loans, consumer credit).

Higher interest rates discourage borrowing and encourage saving. Consumers postpone big-ticket purchases (cars, houses), and firms cut back on investment in new projects because the cost of capital has risen. Aggregate demand falls, reducing upward pressure on prices. In short, expensive credit shrinks the money supply in circulation and cools inflationary pressures.

2. Raising the Cash Reserve Ratio (CRR)

The Cash Reserve Ratio is the fraction of total deposits that commercial banks must hold as reserves with the Central Bank. For example, if CRR is 4%, a bank with ₹100 crore in deposits must park ₹4 crore with the RBI and can lend out only ₹96 crore. …