What happens when the central bank increases the bank rate in an economy

Step 1: Analyze the question The question asks about the effect of the central bank raising the bank rate. In Nigeria, this is similar to the Monetary Policy Rate (MPR) set by the CBN.

Step 2: Explain the concept The bank rate is the rate at which the central bank lends to commercial banks. It is a tool of monetary policy.

• Higher bank rate → it costs commercial banks more to borrow from the central bank → they raise their own lending rates → borrowing becomes more expensive → less borrowing, less spending, and a smaller money supply. This is a contractionary policy used to fight inflation.
• Lower bank rate → cheaper credit → more borrowing and spending → a larger money supply. This is an expansionary policy.

Step 3: Work through the options

• A. Borrowing is discouraged: Correct. Higher interest rates make loans costlier, so people and businesses borrow less.
• B. Customers increase their borrowing: Wrong. Higher rates reduce borrowing, not increase it.
• C. Banks can increase their lending: Wrong. Banks face higher costs and pass them on, so lending falls.
• D. Money supply increases: Wrong. Less credit creation means the money supply falls or grows more slowly.

Step 4: Answer

The correct answer is A: borrowing is discouraged.

Exam tip: Remember "Rate up, borrowing down." A higher bank rate means tight money, so less credit, less spending and lower inflation. A lower bank rate does the opposite. If an option says borrowing or the money supply increases when the rate goes up, it is almost certainly wrong.