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Suppose that financial uncertainty leads to an increase in spread between the repo rate and the interbank rate. What should the central bank do?

answer

The interbank rate determines the cost of funds for banks and thereby the bank lending rates and other interest rates which affect consumption and investment (e.g. home mortgage rates). Thus, an increase in the margin will raise the level of all interest rates in the economy (including mortgages). Assuming that interest rates were where the central bank wanted them to be before the increase in financial uncertainty, then if the margin increases, the central bank should reduce its repo rate so as to compensate for the increase in the margin. If it does not, interest rates throughout the economy will rise, and there will be lower demand and production.