Monetary Policy & RBI Tools — Set 12

Correct Answer: C. Section 45ZB

The Monetary Policy Committee (MPC) was constituted under Section 45ZB of the Reserve Bank of India Act, 1934, as inserted by the amendment in 2016. Section 45ZA deals with the inflation target, Section 45ZB with the composition of MPC, and Section 45ZL requires the MPC to publish its monetary policy report within 14 days of each meeting.

Correct Answer: B. Compensation for expected inflation built into nominal interest rates

The inflation premium is the extra return that lenders demand in nominal interest rates to compensate for expected inflation. If expected inflation is 5%, lenders will demand at least 5% extra (plus the real return) in nominal rates. This is captured in the Fisher Effect: Nominal Rate = Real Rate + Expected Inflation Rate.

Correct Answer: A. Repo Rate → MCLR → Lending Rate → Investment → Inflation

The monetary policy transmission sequence is: RBI changes the Repo Rate → Banks adjust MCLR/EBLR (lending benchmark rates) → Retail lending rates (home, auto, corporate loans) change → Investment and consumption decisions respond → Output and inflation adjust. The full effect on inflation typically takes 3-6 quarters due to transmission lags.

Correct Answer: B. Central bank's large-scale purchase of financial assets to inject money

Quantitative Easing (QE) is an unconventional monetary policy where a central bank purchases large amounts of government bonds or other financial assets from the open market to inject money into the economy when conventional rate cuts are ineffective (near-zero interest rates). The US Fed, ECB, and Bank of England used QE extensively after the 2008 financial crisis.

Correct Answer: B. It automatically changes with the repo rate maintaining the 25 bps differential

The Reverse Repo Rate is typically maintained at 25 basis points (0.25%) below the Repo Rate. When the MPC changes the Repo Rate, the Reverse Repo Rate also adjusts to maintain this 25 bps differential. However, since April 2022, the SDF (Standing Deposit Facility) rate has effectively replaced the reverse repo rate as the floor of the LAF corridor.

Correct Answer: B. Central bank buying financial assets (bonds/securities) to inject liquidity

An asset purchase programme refers to a central bank's systematic purchase of financial assets (government bonds, corporate bonds, mortgage-backed securities) to inject liquidity into the financial system. India's G-SAP (Government Securities Acquisition Programme), announced by RBI in 2021, was a form of asset purchase programme to manage government bond yields during COVID-19.

Correct Answer: B. Currency board issues currency only backed by foreign reserves at a fixed rate

A currency board is a monetary institution that issues domestic currency only fully backed by a foreign reserve currency at a fixed exchange rate. Unlike a central bank, a currency board cannot independently set interest rates or conduct OMOs. Hong Kong operates under a currency board arrangement pegged to the US dollar. India has a central bank (RBI) with more flexibility.

Correct Answer: B. Regulating the volume and direction of bank credit in the economy

Credit control is one of the most important functions of the Reserve Bank of India, involving the regulation of the volume, cost, and direction of credit extended by commercial banks. RBI uses both quantitative tools (CRR, SLR, Repo Rate) and qualitative tools (margin requirements, moral suasion) to ensure credit flows align with macroeconomic objectives of growth and price stability.

Correct Answer: B. Currency in circulation + Bankers' deposits with RBI + Other deposits with RBI

Reserve Money (M0), also called High-Powered Money or Monetary Base, consists of: (1) Currency in circulation (notes and coins with public and in bank vaults), (2) Bankers' deposits with RBI (CRR + excess reserves), and (3) Other deposits with RBI. M0 is the base from which broader money supply aggregates (M1, M2, M3, M4) are derived through the money multiplier.

Correct Answer: C. RBI manages exchange rate through interventions (managed float)

India follows a 'managed float' or 'dirty float' exchange rate regime. The Indian rupee is largely market-determined, but the RBI intervenes in the foreign exchange market (buying or selling dollars) to prevent excessive volatility. RBI does not target a specific exchange rate level but aims to maintain orderly market conditions.