De-Jargonize

1. Liquidity trap
Liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand.

From household’s side

A situation in which prevailing interest rates are low and savings rates are high that is consumers choose to avoid bonds and keep their funds in savings. Bonds have an inverse relationship to interest rates; many consumers do not want to hold an asset with a price that is expected to decline.

From firms’ side

It usually arises when expected returns from investments in securities or real plant and equipment are low, investment falls, a recession begins, and cash holdings in banks rise. Businesses continue to hold cash because they expect spending and investment to be low. This is a self-fulfilling trap.

2. Seigniorage

Seigniorage is defined as revenue for a government when the money that is created is worth more than it costs to produce it. This revenue is often used by government to finance a portion of their expenditures without having to collect taxes. It is the value the government generates by adding its stamp to an ordinary piece of paper, piece of metal or nowadays an electronic bank entry.
Seigniorage =the face value of the money - the cost of printing/ minting it.
For example, it costs the Indian government Rs 2 to produce a note of Rs 10, the seigniorage is Rs.8

3. Repo rate 

Whenever a bank has a shortage of funds they can typically borrow it from the central bank based on the monetary policy of the country. Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks for meeting shortfalls in their reserve requirements against securities. Repo rate is used by monetary authorities to control inflation.

How repo rate affects the economy?

In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in controlling inflation.

4. Reverse repo rate

Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is mostly done when there is surplus liquidity in the market. It is a monetary policy instrument which can be used to control the money supply in the country.

How reverse repo rate affects the economy?

An increase in reverse repo rate means that commercial banks will get more incentives to park their funds with the RBI, thereby decreasing the supply of money in the market.

5. Statutory Liquidity Ratio (SLR)

SLR is the amount a commercial bank needs to maintain in the form of cash, gold, or government approved securities before providing credit to its customers. SLR is determined and maintained by RBI in order to control the expansion of bank credit. In simple words, it is the percentage of total deposits banks have to invest in government bonds and other approved securities. A SLR bond also qualifies for the portfolio maintained by banks to meet the liquidity requirement.

Contributed by:

Shreya Jain
Economics, Section A
Batch 2013-15