If in an economy Bank rate is increased, how will it affect the demand for credit ? Explain.

Question

Accepted Answer

When Bank Rate is increased, the demand for credit decreases.

Explanation:
1. Bank Rate is the rate at which central bank lends to commercial banks for long-term needs
2. Increase in Bank Rate increases cost of borrowing for commercial banks
3. Commercial banks increase their lending rates to maintain profit margins
4. Higher lending rates discourage borrowers from taking loans
5. This reduces the demand for credit in the economy

The transmission mechanism:
Bank Rate ↑ → Cost of funds for banks ↑ → Lending rates ↑ → Borrowing becomes expensive → Demand for credit ↓