Please explain the role of "Reverse Repo Rate" in correcting the situation of excess and deficit demand.

Solution:
Reverse repo rate is the rate at which central bank (RBI) borrow money from commercial bank.
When there is excess demand that is aggregate demand is more than  aggregate supply than reverse repo rate will be increased thus commercial bank lends more money to central bank and flow of money will reduce in market that ultimately control excess demand and equilibrium situation achieved.
In deficit demand , that is aggregate demand is less than aggregate supply. Central bank reduces reverse repo rate, thus commercial bank lends less money to central bank and flow of money increases in market and aggregate demand increases and market is able to achieve equilibrium again.

 

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