Monetary Policy — Set 8

Correct Answer: D. A sudden increase in crude oil prices

Supply-side factors, also known as 'cost-push' factors, occur when the cost of production rises. A hike in global oil prices increases transportation and manufacturing costs, leading to general price rises. Monetary policy is often less effective in controlling this type of inflation compared to 'demand-pull' inflation.

Correct Answer: D. Hyperinflation

Hyperinflation is an extreme economic scenario where prices rise at an exceptionally rapid pace, often exceeding 50% per month. It usually happens due to excessive money printing and a complete loss of confidence in the currency. It has occurred historically in countries like Germany in the 1920s and Zimbabwe in the 2000s.

Correct Answer: C. High inflation combined with high unemployment

Stagflation is a difficult situation for a central bank because the tools to fight inflation (higher rates) can worsen the stagnant growth and unemployment. It usually occurs due to supply shocks like an oil crisis. The term is a combination of 'stagnation' and 'inflation'.

Correct Answer: D. By making borrowing more expensive and

When Repo rate increases, the cost of funds for banks goes up, which they pass on to consumers through higher EMI and loan rates. Higher interest rates encourage people to save more and spend less, reducing the overall demand. This decrease in demand eventually leads to a cooling of prices.

Correct Answer: C. Financial Markets

The correct answer is 'Financial Markets'. The FMOD is the executive arm of the RBI that implements the monetary policy resolution on the ground. It conducts the daily Repo/Reverse Repo auctions and OMOs as decided by the committee. It ensures that the market interest rates stay in line with the policy goals.

Correct Answer: C. When people pay the bank to keep their money

Under a negative interest rate policy, the central bank charges commercial banks for keeping excess reserves. The goal is to force banks to lend money to businesses and consumers rather than holding onto it. It is an extreme measure used when traditional rate cuts fail to stimulate the economy.

Correct Answer: C. A situation where people prefer to hold cash

The correct answer is 'A situation where people prefer to hold cash'. In a liquidity trap, consumers and investors expect a disaster or deflation and refuse to spend despite very low interest rates. Monetary policy becomes ineffective in this state because lowering rates further has no impact on demand. It often requires government 'fiscal' intervention to revive the economy.

Correct Answer: A. To print more 2000 rupee notes

OMOs are purely a tool for managing the supply of money and the level of interest rates in the economy. Printing currency is a separate function related to the 'Issue Department' of the RBI. OMO is a powerful 'indirect' tool of monetary policy.

Correct Answer: D. 40%

The Banking Regulation Act gives the RBI the authority to set the SLR anywhere from 0% to 40% of the bank's liabilities. It is currently maintained much lower than the maximum limit to ensure banks have enough funds for commercial lending. Changes in SLR are used as a long-term liquidity and prudential tool.

Correct Answer: B. Demand-pull inflation

Demand-pull inflation happens when the growth in the money supply or consumer confidence leads to a rise in total spending. When this spending exceeds the economy's capacity to produce goods, prices are pulled upward. This is the type of inflation most directly controlled by interest rate hikes.