Question

What is 'Excess Demand'? Explain the role of 'Reverse Repo Rate' in removing it.

Answer 1

Excess demand refers to a situation when Aggregate Demand (AD) is in excess of Aggregate Supply (AS) corresponding to full employment in the economy. It causes Inflationary Gap in the economy. Price level tends to rise without any rise in the level of income or employment.
Reverse Repo Rate-Reverse Repo Rate is the rate of interest at which Commercial Banks can park their surplus funds with the Central Bank, for short period. If Reverse Repo Rate is increased, then it is followed by increase in market rate of interest. Accordingly, cost of credit also increases. It will reduce flow of credit as desired.