Repo (short for repurchase) rate is the rate at which a central bank (such as the Federal Reserve in the United States) lends money to commercial banks in exchange for collateral, usually government securities. This is a short-term borrowing mechanism used by banks to meet their liquidity needs.
Reverse repo rate, on the other hand, is the rate at which the central bank borrows money from commercial banks by selling government securities to them, with an agreement to repurchase them at a later date. This is a short-term lending mechanism used by central banks to manage the money supply in the economy.
In both cases, the interest rates on these transactions are set by the central bank and are used to influence the level of liquidity in the banking system. When the central bank wants to increase the money supply, it can reduce the repo rate, which makes it cheaper for banks to borrow money and increases the availability of credit in the economy. Conversely, when the central bank wants to reduce the money supply and curb inflation, it can increase the repo rate, which makes it more expensive for banks to borrow money and reduces the availability of credit.
The reverse repo rate also plays an important role in monetary policy. By increasing the rate, the central bank can incentivize banks to deposit their excess funds with the central bank instead of lending them out, which reduces the level of liquidity in the banking system.
Overall, the repo and reverse repo rates are important tools used by central banks to manage the money supply and achieve their monetary policy objectives.