Let’s start with the concept of repo rate :
What is repo rate ?
Repo rate is the rate at which Central bank gives loans to commercial bank against unencumbered securities and government Bonds . In other words , we can say it’s same as commercial bank giving loans to customer against some assets or securities, the difference here is during hard times when commercial bank needs loan Central bank will help them against securities and the buyer (central bank ) promises to sell those same securities and bond to the original owner at decided interest rate and at slightly higher price is called reverse repo rate. Reverse Repo rate is always lower than repo rate . The current repo rate in India is 4.90% and reverse repo rate is at 3.35%.
How does Central bank uses to stabilise the economy?
Central bank uses repo rate to increase liquidity in the market whereas it uses reverse repo rate to absorb excess liquidity from the market. When central bank wants to increase the money supply in the market they will decrease the repo rate, the result will be -commercial bank will get cheaper loans and they will avail cheaper loans to customer too and when central bank wants to soak liquidity from the market they will increase the repo rate because of that loans will become expensive . During inflation Central bank rises repo rate and reverse repo rate too and during deflation it decreases repo rate and reverse repo rate .
Current scenario – Inflation is burning the notes of poor.
Since May 2020 the central bank of India – RESERVE BANK OF INDIA (RBI) have kept the same repo rate 4% till May 2022. On May 4,2022 it increased it by 40 points (I.e 4.40%) and on June 8,2022 it increased it by 50 points ( I.e 4.90%). The government has mandated RBI to maintain the inflation rate at 4% with the margin of 2. But since January 2022 RBI hasn’t be able to maintain it . The inflation rate has been continuously increasing, it has remained above the upper tolerance level of RBI (6%) for the 4th successive month. The prices of essential food items is increased by 50% whereas the real wage rate is only increased by 22%. To control inflation and to maintain its margin level RBI decided to increase repo rate to stop commercial bank to lend money at cheaper rate.
The current unemployment rate of India is 7.83% . Here because of price hikes, the demand of product is decreasing and company’s are firing employees in a large number which is setting back India against the fight with inflation. India’s inflation and unemployment graphs are not according to the theory of A.W Philips , he stated that when inflation increases unemployment decreases; they have a negative relation. According to him inflation brings economic growth and on turn leads to greater employment, but, the current situation of India is totally different than he stated . The increase in inflation rate led to increase in unemployment rate . We can say that India is in state of stagflation and from here we can also say that inflation is positively related to unemployment in this ( stagflation) situation..