It is the maximum rate at which the Central Bank of a country provides loans to the
commercial Banks in an economy, also called the discount rate because in earlier times
Central Banks used to provide finance to the community banks by rediscounting rate of discount. Through changes in the bank rate the Central Bank influences the amount of credit creation.
When Central Bank raises the bank rate, the cost of borrowing by commercial banks from Central Bank increases discouraging borrowing. Banks also raises their lending rates, eventually businessmen and individuals will feel discouraged to borrow from commercial. Banks. This lead to contraction in bank credit resulting in a reduction in aggregate demand which further results to decrease in prices.
Alternatively when there is depression and deflation in the economy the bank rate is lowered to overcome it. This will cause reduction in lending rate, with credit becoming cheaper money is borrowed from commercial Banks for investment and other purposes thus increase in Aggregate Demand for goods and services brings about recovery in the economy. If a country permits the free flow of funds in and out of the country then the Central Bank rate will also have an effect on the external policy. For instance if the bank rate is increased, the increased deposit rates will make funds from outside the country attracted in the country bringing about a favorable balance of payments.
Kavungya answered the question on March 26, 2019 at 05:49