Economy 2021 MCQs

Lending to Governments for Financing Budgetary Deficits:

• The Reserve Bank of India (RBI) has traditionally provided liquidity to the government to smoothen temporary mismatches between revenue and expenditure, against government securities.
• However, this practice has evolved with a clear distinction between debt management and monetary management to avoid the inflationary implications of financing government deficits directly.
• The management of public debt, which includes issuing new debt to the non-government sector to offset the liquidity impact of fiscal deficits, has seen a shift towards minimizing the central bank's direct financing of government deficits due to its inflationary potential​​.

Providing Liquidity to Banks in Crisis (Lender of Last Resort):

• The RBI's role as the lender of last resort is primarily aimed at ensuring the stability of the banking sector by providing liquidity to solvent but illiquid banks to avert systemic crises.
• This function is foundational to central banking and is exercised to prevent bank panics by supplying liquidity at a penalty rate to discourage banks from taking excessive risks.
• The lender of last resort function has evolved to cover not only commercial banks but also other financial institutions, reflecting the expanding role of central banks in maintaining financial stability beyond just the banking sector​​.

Lending to Trade and Industry-Bodies:

• While the RBI plays a significant role in regulating and supervising the financial sector, including direct interventions in times of crisis, its function as a lender of last resort does not typically extend to lending directly to trade and industry bodies.
• The primary focus is on maintaining the stability of the financial system, with interventions aimed at liquidity support for the banking sector rather than direct financial support to non-bank entities​​​​​​.

Source: https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=454

https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=249

Statement 1 is correct.

• The Water Credit Initiative indeed leverages microfinance tools to provide small, affordable loans for water and sanitation to those in need.
• This approach is designed to overcome the barrier of affordable financing, allowing individuals and families to access water and sanitation solutions.
• This initiative has been proven effective over more than 15 years, significantly impacting millions of lives by making water and sanitation loans accessible to those who need them the most​​.

Statement 2 is incorrect.

• Water Credit is an innovation of Water.org, a global nonprofit organization co-founded by Gary White and Matt Damon.
• Water.org works to bring water and sanitation to the world through affordable financing, such as small loans, and has been doing so for over 30 years.
• The organization focuses on creating market-driven financial solutions to the global water crisis​​.

Statement 3 is correct.

• By providing access to affordable financing, Water Credit empowers individuals and families living in poverty to finance long-term water and sanitation solutions on their own, reducing their reliance on day-to-day struggles for water or the need for direct subsidies.
• The initiative recognizes people as consumers with autonomy and supports them in defining their own futures, with a high loan repayment rate indicating its sustainability and effectiveness​​.

Source:

• https://water.org/solutions/watercredit/
• https://water.org/about-us/

Retail investors can invest in Treasury Bills and Government of India Debt Bonds in the primary market through a demat account.

• Retail investors have multiple channels to invest in these securities in the primary market, utilizing the non-competitive bidding facility offered by NSE.

Source: https://www.nseindia.com/products-services/non-competitive-bidding-how-to-invest-g-sec

The 'Negotiated Dealing System-Order Matching' (NDS-OM) is indeed a government securities trading platform of the Reserve Bank of India (RBI).

• It is designed for the secondary market transactions, where retail investors, upon successful registration, can access this platform for buying or selling government securities.

Source: https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51883

Regarding the 'Central Depository Services Ltd. (CDSL)

• It is not jointly promoted by the Reserve Bank of India and the Bombay Stock Exchange.
• CDSL was established by the Bombay Stock Exchange (BSE) along with other Indian financial institutions, banks, and investment companies.

Source: https://www.cdslindia.com/Downloads/InvestorRels/AnnualReports/CDSL%20AR%202019%20FULL%20FILE%209.00%20PM.pdf

Expansionary Policies:

• When the government or the central bank (in India's case, the Reserve Bank of India) decides to pump more money into the economy, it's usually through lowering interest rates or increasing the money supply.
• This makes borrowing cheaper and encourages spending and investment.
• It is a well-acknowledged economic principle that such policies can increase aggregate demand, potentially leading to inflation if the supply does not match up​​.

Fiscal Stimulus:

• This is about the government spending more or cutting taxes to boost economic activity.
• The idea is that when the government spends more, directly or through subsidies, it increases overall demand. For instance, government expenditure, as part of aggregate demand, can push prices up if it outpaces supply capabilities.
• The Reserve Bank of India's reports and forecasts often reflect on the impacts of government spending and fiscal deficits on the economy.
• However, it's broadly understood in economic theory that fiscal stimulus, by boosting consumption and investment, can contribute to demand-pull inflation​​.

Inflation-indexing Wages:

• This practice involves adjusting wages based on inflation rates to maintain the purchasing power of consumers.
• It's a bit more complex because while it's designed as a response to inflation, indexing wages to inflation can perpetuate it by ensuring that consumer demand remains high, even as prices rise.
• The reviewed material didn't explicitly address inflation-indexed wages in the Indian context, but the concept is globally recognized as a potential factor in sustaining or escalating demand-pull inflation due to its impact on maintaining or even increasing consumer spending power.

Higher Purchasing Power:

• This naturally leads to increased demand. When people have more disposable income—be it through wage increases, tax cuts, or other means—they tend to spend more.
• This increased spending can drive prices up, especially if the supply side doesn't keep pace.
• The RBI's analysis on economic conditions, consumer confidence, and spending patterns indirectly touches on how variations in purchasing power, through mechanisms like fiscal policies and credit expansion, can impact inflation and demand​​.

Rising Interest Rates:

• Interestingly, this factor typically works in the opposite direction of demand-pull inflation.
• Higher interest rates make borrowing more expensive and can cool down an overheated economy by slowing down spending and investment.
• This is often used as a tool to combat inflation, not cause it.
• Therefore, while rising interest rates are a critical part of monetary policy, they are generally aimed at controlling, not increasing, demand-pull inflation.

Source: https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=21343

Increase in the Cash Reserve Ratio (CRR) in the banks:

• The CRR is the percentage of depositors' balances banks must hold as reserves with the central bank.
• Increasing the CRR would actually decrease the money multiplier because banks have less money to lend out.
• Higher reserves mean banks can support fewer deposits through lending, which decreases the money creation process.

Increase in the Statutory Liquidity Ratio (SLR) in the banks:

• Similar to the CRR, the SLR is the percentage of deposits that banks must maintain in the form of liquid assets themselves, not with the central bank.
• Increasing the SLR also reduces the money multiplier by reducing the amount of funds available for banks to lend out.

Increase in the banking habit of the people:

• When more people start using banking services, depositing their money in banks instead of holding it as cash, banks have more funds to lend out.
• This increases the base for the money multiplier effect, as each deposited unit can be lent and re-deposited several times, expanding the money supply in the economy.

Increase in the population of the country:

• While an increasing population might lead to a higher demand for money and possibly more deposits and lending activities, it does not directly affect the money multiplier mechanism.
• The impact would depend on the banking habits of the population and other economic factors.

• Repayment of public debt typically doesn't directly lead to inflation. It's a neutral action where the government is fulfilling its debt obligations, which doesn't inherently increase the money supply or demand within the economy.
• Borrowing from the public to finance a budget deficit involves the government issuing securities, such as bonds, to raise funds. This method doesn't immediately increase the money supply since it's reallocating existing money from investors to the government. While it might influence interest rates and investment behaviors, its direct inflationary effect is limited compared to other methods​​.
• Borrowing from banks to finance a budget deficit can be somewhat inflationary since it might lead to an increase in the money supply if banks create new deposits in the process of lending to the government. However, this impact is moderated by the central bank's monetary policy and regulatory frameworks, which aim to manage liquidity and control inflation​​.
• Creation of new money to finance a budget deficit, also known as monetizing the debt, is the most directly inflationary method among the options. When the central bank or the government creates new money to cover a budget deficit, it directly increases the money supply without a corresponding increase in goods and services, potentially leading to inflation. This action can dilute the value of money, leading to price increases across the economy​​.

• The primary concern regarding the effects of black money in India has been its significant impact on the loss of revenue to the State Exchequer due to tax evasion.
• The Government of India has been proactive in addressing this issue through various measures aimed at curbing black money, both domestically and stashed abroad.
• One of the pivotal steps taken by the government was the implementation of the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.
• This act was specifically designed to tackle the issue of black money stored outside the country.
• As a result of the government's systematic actions, substantial undisclosed income has been brought to tax, leading to the levy of penalties and the raising of significant demand in various cases related to undisclosed foreign income and assets​​.
• Furthermore, the government has also focused on widening the tax base and enhancing direct tax collections as part of its efforts to combat black money.
• Notable initiatives like demonetization were aimed at flushing out black money, converting the non-formal economy into a formal one, and expanding the tax base.
• This initiative saw a remarkable increase in enforcement actions, a surge in the number of e-returns filed by individual taxpayers, and a significant boost in direct tax collections, highlighting the government's commitment to tackling the issue of black money​​.
• These efforts underscore the government's main concern with black money: its detrimental impact on the country's revenue and the formal economic sector.
• By implementing stringent measures and leveraging data analytics for enforcement actions, the government aims to minimize tax evasion and enhance compliance, thereby safeguarding the State Exchequer's interests.

Source: https://pib.gov.in/PressReleasePage.aspx?PRID=1739186

Improves the competitiveness of the domestic exports in foreign markets:

• This statement is correct. When a currency is devalued, domestic goods and services become cheaper for foreign buyers. This can lead to an increase in demand for domestic exports because they are more competitively priced in the global market.

Increases the foreign value of domestic currency:

• This statement is incorrect. Devaluation means that the domestic currency has been made weaker compared to foreign currencies. Therefore, it decreases the foreign value of the domestic currency, not increases it. This means that you need more of the domestic currency to buy foreign currencies.

Improves the trade balance:

• This statement is incorrect. Improving the trade balance depends on the elasticity of demand for exports and imports. If the increase in volume of exports due to lower prices (caused by devaluation) and the decrease in imports because of higher foreign prices lead to a higher value of exports relative to imports, then the trade balance can improve. However, this is known as the Marshall-Lerner condition, and it depends on the specific elasticities of demand for exports and imports. It's not a guaranteed outcome of devaluation.

Actions of the United States Federal Reserve:

• The U.S. Federal Reserve's monetary policies can have a significant impact on global financial markets, including India.
• For instance, the Fed's decisions on asset purchases and interest rate policies can lead to spillover effects in emerging markets like India, affecting the flow of foreign portfolio investments and influencing Indian bond yields​​.

Actions of the Reserve Bank of India (RBI):

• The RBI's monetary policy, including decisions on the policy repo rate and open market operations, directly impacts the liquidity in the market and subsequently the yields on government securities.
• The RBI's role in managing the country's monetary policy and regulating the financial system plays a crucial part in determining bond yields​​.

Macroeconomic Variables (Inflation and Interest Rates):

• Macroeconomic factors, including inflation rates and the overall economic outlook, are key determinants of bond yields. Expectations around inflation and economic growth influence investor sentiment and demand for government securities, thereby affecting yields.
• Furthermore, the short-term interest rates set by the central bank are a critical factor, as they directly influence the cost of borrowing and the yield on bonds​​.

Source: https://compass.rauias.com/current-affairs/what-is-bond-yield/

They are supervised and regulated by local boards set up by the State Governments.

• This statement is incorrect. Urban Cooperative Banks are supervised and regulated by the Reserve Bank of India (RBI), not by local boards set up by State Governments. The RBI's Urban Banks Department is vested with the responsibility of regulating and supervising primary (urban) cooperative banks​​.

They can issue equity shares and preference shares.

• Recent reforms have indeed allowed cooperative banks, including Urban Cooperative Banks, to issue equity or preference shares, subject to certain conditions and approvals. This change is part of efforts to strengthen their capital base​​.

They were brought under the purview of the Banking Regulation Act, 1949 through an Amendment in 1966.

• Urban Cooperative Banks were brought under the purview of the Banking Regulation Act, 1949, through an amendment in 1966. This was a significant move that aimed to bring these banks under a regulatory framework similar to that governing other commercial banks in the country​​.

Source: https://compass.rauias.com/current-affairs/regulation-urban-cooperative-banks/

Price of its substitute increases:

• If the price of a substitute good increases, consumers will likely switch to the relatively cheaper good, increasing its demand. This statement is correct.

Price of its complement increases:

• When the price of a complement increases, the demand for the main good usually decreases because the overall cost of consuming both goods together increases. This statement is incorrect.

The good is an inferior good and income of the consumers increases:

• For an inferior good, as consumers' income increases, they tend to buy less of the inferior good and switch to higher-quality alternatives. Therefore, if income increases, the demand for an inferior good will decrease. This statement is incorrect.

Its price falls:

• When the price of a good falls, its demand generally increases as more consumers are willing and able to purchase it at the lower price. This statement is correct.

Cut in tax rates accompanied by increase in interest rate:

• Cutting tax rates is a fiscal policy aimed at increasing disposable income for consumers and investment capacity for businesses, which can stimulate economic growth.
• However, increasing interest rates is a monetary policy tool typically used to combat inflation or cool down an overheating economy, not actions typically taken during a recession when the goal is often to encourage borrowing and spending.

Increase in expenditure on public projects:

• This is a classic fiscal policy approach used to combat recessions. By increasing expenditure on public projects, the government injects money into the economy, creating jobs, and stimulating demand through increased spending.
• This approach is based on Keynesian economic theory, which advocates for increased government expenditures and lower taxes to stimulate demand and pull the economy out of a recession.

Increase in tax rates accompanied by reduction of interest rate:

• Increasing tax rates during a recession would likely reduce disposable income for consumers and investment for businesses, potentially deepening the recession.
• Reduction of interest rates is a common monetary policy measure to stimulate economic activity by making borrowing cheaper, encouraging spending and investment.
• The combination of these two policies sends mixed signals and could be counterproductive, with the tax increase potentially offsetting the stimulative effect of lower interest rates.

Reduction of expenditure on public projects:

• Reducing government expenditure on public projects during a recession would likely lead to a decrease in overall demand in the economy.
• This is because such spending cuts reduce the amount of government-induced economic activity, potentially worsening the recession.

Source: https://compass.rauias.com/current-affairs/k-shaped-economic-recovery-in-india/

All casual workers are entitled to Employees Provident Fund (EPF) coverage:

• This statement is correct as the Employees' Provident Funds and Miscellaneous Provisions Act, 1952, does not distinguish between different types of employees regarding EPF coverage.
• The Supreme Court of India has also affirmed that casual workers are entitled to social security benefits under the EPF Act, reinforcing the inclusivity of the Act towards all categories of workers​​.

All casual workers are entitled to regular working hours and overtime payment:

• The statement is correct finds its basis in labor laws, specifically the Minimum Wages Act, 1948, and the Factories Act, 1948, which regulate working hours and stipulate provisions for overtime payment across various types of employment, including casual workers.
• Workers are entitled to overtime pay at specified rates if they work beyond the standard working hours​​.

The government can by a notification specify that an establishment or industry shall pay wages only through its bank account:

• This statement is correct as per amendments made to the Payment of Wages Act, 1936, by the Payment of Wages (Amendment) Act, 2017, which allows the government to mandate payment of wages through banking channels.
• This provision aims to promote transparency and efficiency in the disbursement of wages​​.

Source: https://compass.rauias.com/current-affairs/the-problem-associated-with-the-indian-informal-sector/

The Governor of the Reserve Bank of India (RBI) is appointed by the Central Government.

• This statement is correct. According to Section 8 of the RBI Act, 1934, the Governor and Deputy Governors of the RBI are appointed by the Central Government.

Certain provisions in the Constitution of India give the Central Government the right to issue directions to the RBI in public interest.

• This statement is incorrect. There are no provisions in the Constitution of India that specifically give the Central Government the right to issue directions to the RBI. However, the RBI Act, 1934, does provide for such provisions.

The Governor of the RBI draws his power from the RBI Act.

This statement is correct. The powers and functions of the RBI Governor are derived from the RBI Act, 1934. The Act empowers the Governor to manage the affairs of the bank and exercise all powers that can be exercised by the RBI.

Reserve Bank of India

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