MONEY AND BANKING (Part – I)

41. Which of the following statement is correct? [Uttarakhand P.C.S (Pre) 2021]

(a) Inflation benefits the bond holders.
(b) Inflation benefits the debtors.
(C) Inflation benefits the fixed income groups.
(d) None of these.

Correct Answer: (b) Inflation benefits the debtors.

Solution:Inflation occurs when there is a general increase in the price of goods and service and a fall in purchasing value of money . Inflation allows debtors (borrowers) to pay creditors (lender) back with money worth less than when it was originally borrowed, which benefits debtors. Thus inflation brings about a redistribution of real wealth in favour of debtors at the cost of creditors. Investors in bonds and securities with fixed interest rates, consumers, fixed income groups pensioners etc. also lose in real terms during inflation.

42. A zero rate of inflation obtains necessarily in a year where the annual rate of inflation : [U.P.S.C (Pre) 1993]

(a) in every week of the year is zero.
(b) is falling in every week of the year.
(C) is both falling and rising in a year.
(d) is constant in every week of the year.

Correct Answer: (a) in every week of the year is zero.

Solution:If there is a 5 percent inflation in a particular week of a month in a year , it means that in comparison to same week of the same month in previous year. the prices of goods have increased by 5 percent. It means inflation is measured on the basis of week. Hence, it is clear that to get a zero rate of inflation, the annual rate of inflation in every week of the year should be zero.

Inflation impacts various aspects of the economy, from reducing purchasing power and increasing interest rates to widening income inequality and affecting investment returns. It also hampers export competitiveness and raises business costs, complicating economic planning.
Reduced Purchasing Power: Inflation erodes the purchasing power of money, meaning consumers can buy fewer goods and services with the same income, ultimately affecting their quality of life and standard of living.
Increased Interest Rates: To control inflation, central banks often raise interest rates, making borrowing more expensive for individuals and businesses, which can slow down economic growth and investment activities.
Income Inequality: Inflation impacts income groups unevenly. Lower-income households feel the pinch more as a larger portion of their income goes toward essentials, widening the gap between socioeconomic classes.
Investment Returns: Inflation diminishes real returns on investments, especially fixed-income assets, as the actual purchasing power of returns is reduced, potentially discouraging savings and long-term investment.
Export Competitiveness: Rising domestic prices make exports less competitive internationally, as foreign buyers may seek cheaper alternatives elsewhere, potentially harming industries that rely on exports for revenue.
Business Costs and Planning: Inflation raises operational costs for businesses, especially in materials and labour, leading to challenges in pricing and long-term planning as businesses struggle to maintain profit margins.

43. Assertion (A) : The rate of inflation in India has come down in the last three years. Reason (R) : Foreign investment in the country is increasing rapidly during these years. [U.P.P.C.S (Pre) 1998]

(a) Both A and R are true and R is the correct explanation of A.
(b) Both A and R are true but R is not the correct explanation of A.
(C) A is true, but R is false.
(d) A is false, but R is true.

Correct Answer: (C) A is true, but R is false.

Solution:Based on the average of 52 weeks, the inflation was 10.9% in 1994-95 which came down to 4.8% in 1997-98. Hence, Assertion (A) is correct. In 1994-95 India received 4807 million US $ as foreign investment while it received 5353 million US $ in 1997-98. Thus, it is clear that there was minimal increase in foreign investment during that period. Hence, Reason (R) is incorrect.

Inflation impacts various aspects of the economy, from reducing purchasing power and increasing interest rates to widening income inequality and affecting investment returns. It also hampers export competitiveness and raises business costs, complicating economic planning.
Reduced Purchasing Power: Inflation erodes the purchasing power of money, meaning consumers can buy fewer goods and services with the same income, ultimately affecting their quality of life and standard of living.
Increased Interest Rates: To control inflation, central banks often raise interest rates, making borrowing more expensive for individuals and businesses, which can slow down economic growth and investment activities.
Income Inequality: Inflation impacts income groups unevenly. Lower-income households feel the pinch more as a larger portion of their income goes toward essentials, widening the gap between socioeconomic classes.
Investment Returns: Inflation diminishes real returns on investments, especially fixed-income assets, as the actual purchasing power of returns is reduced, potentially discouraging savings and long-term investment.
Export Competitiveness: Rising domestic prices make exports less competitive internationally, as foreign buyers may seek cheaper alternatives elsewhere, potentially harming industries that rely on exports for revenue.
Business Costs and Planning: Inflation raises operational costs for businesses, especially in materials and labour, leading to challenges in pricing and long-term planning as businesses struggle to maintain profit margins.

44. Which one of the following statements is an appropriate description of deflation? [U.P.S.C (Pre) 2010]

(a) It is a sudden fall in the value of a currency against other currencies.
(b) It is persistent recession in both the financial and real sectors of economy.
(C) It is a persistent fall in the general price level of goods and services.
(d) It is a fall in the rate of inflation over a period of time.

Correct Answer: (C) It is a persistent fall in the general price level of goods and services.

Solution:Inflation denotes rise in general price level in an economy. Deflation is just opposite of inflation which denotes fall in general price level of goods and services in an economy.

Inflation impacts various aspects of the economy, from reducing purchasing power and increasing interest rates to widening income inequality and affecting investment returns. It also hampers export competitiveness and raises business costs, complicating economic planning.
Reduced Purchasing Power: Inflation erodes the purchasing power of money, meaning consumers can buy fewer goods and services with the same income, ultimately affecting their quality of life and standard of living.
Increased Interest Rates: To control inflation, central banks often raise interest rates, making borrowing more expensive for individuals and businesses, which can slow down economic growth and investment activities.
Income Inequality: Inflation impacts income groups unevenly. Lower-income households feel the pinch more as a larger portion of their income goes toward essentials, widening the gap between socioeconomic classes.
Investment Returns: Inflation diminishes real returns on investments, especially fixed-income assets, as the actual purchasing power of returns is reduced, potentially discouraging savings and long-term investment.
Export Competitiveness: Rising domestic prices make exports less competitive internationally, as foreign buyers may seek cheaper alternatives elsewhere, potentially harming industries that rely on exports for revenue.
Business Costs and Planning: Inflation raises operational costs for businesses, especially in materials and labour, leading to challenges in pricing and long-term planning as businesses struggle to maintain profit margins.

45. A rapid increase in the rate of inflation is sometimes attributed to the 'base effect'. What is 'base effect'? [U.P.S.C (Pre) 2011]

(a) It is the impact of drastic deficiency in supply due to failure of crops.
(b) It is the impact of the surge in demand due to rapid economic growth.
(C) It is the impact of the price levels of previous year on calculation of inflation rate.
(d) None of the statements (a) , (b), (c) given above is correct in this context.

Correct Answer: (C) It is the impact of the price levels of previous year on calculation of inflation rate.

Solution:'Base effect' refers to a kind of statistical anomaly that causes steep hike or decline in the rate of price rise or fall because the current prices are compared relative to the previous period. If last year's price of certain articles is low and this year it has returned to its normal price, yet the rate of increase, which is relative to the last year's price, is shown high.

46. Which one of the following governmental steps has proved relatively effective in controlling the double digit rate of inflation in the Indian economy in the recent years? [U.P.S.C (Pre) 1994]

(a) Enhanced rate of production of all consumer goods.
(b) Streamlining public distribution system.
(C) Pursuing an export-oriented strategy.
(d) Containing budgetary deficit and unproductive expenditure.

Correct Answer: (d) Containing budgetary deficit and unproductive expenditure.

Solution:Revenue deficit is considered as an unproductive expenditure of the government, which was 3.3% of GDP in the year 1990- 91 and reduced to 2.5% of GDP, in the year 1992-93. It means, unproductive expenditure had been reduced during these years. Budgetary deficit, which is the sum of revenue deficit and capital deficit, had also decreased, because revenue deficit was less than earlier. The concept of budgetary deficit was discontinued in the year 1997-98.

47. Which of the following factors could potentially contribute to stagflation in the Indian Economy? [69th B.P.S.C (Pre) 2023]

1. High inflationary pressures due to increased Government spending.
2.Decline in industrial production and sluggish economic growth.
3.Decrease in aggregate demand and consumer spending.
4. Appreciation of the domestic currency leading to reduction of export competitiveness.

Select the correct answer using the codes given below.

(d) 1, 2, 3. and 4
(a) only 1 and 2
(b) only 2 and 3
(C) only 1, 3 and 4

Correct Answer: (d) 1, 2, 3. and 4

Solution:Stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. All four given factors could potentially contribute to stagflation in the Indian Economy.

Stagflation is often triggered by supply-side shocks, such as a sudden increase in the price of essential resources like oil, which raises production costs and prices while simultaneously slowing down economic activity. Stagflation creates uncertainty for businesses and consumers, leading to reduced investment and spending, further exacerbating the economic slowdown.
Stagflation was a significant economic problem in the 1970s, particularly in the United States, due to a combination of factors, including oil price spikes and misguided economic policies. The experience of the 1970s highlighted the difficulty of managing an economy experiencing stagflation and the limitations of traditional economic theories in addressing such a situation.

48. Given below are two statements one is labelled as Assertion (A) and other as Reason (R) : [U.P.P.C.S (Pre) 2021]

Assertion (A):The government faces a tough time trackling the bottleneck inflation.
Reason (R) :The situation is due to deficiencies existing in the economy such as supply bottleneck and inefficient distribution.

Select the correct answer from the codes given above.
Codes :

(a) Both (A) and (R) are true and (R) is correct explanation of (A)
(b) Both (A) and (R) are true, but (R) is not correct explanation of (A)
(C) (A) is true, but (R) is false
(d) (A) is false, but (R) is true

Correct Answer: (a) Both (A) and (R) are true and (R) is correct explanation of (A)

Solution:Bottleneck inflation is the inflation that takes place when supply falls drastically while demand remains at the same level. This creates excess demand in the economy as the supply cannot match it and thus results in rising of prices. Such situations arise due to supply-side accidents, hazards, mismanagement or inefficient distribution. The government faces a tough time in this situation of inflation. Hence, both Assertion and Reason are true and Reason is the correct explanation of Assertion.

49. Consider the following statements regarding inflation : [Raj. P.C.S (Pre) 2023]

Statement(A):Headline inflation refers to the rate of change in the Consumer Price Index Number, a measure of the average price of a standard basket of goods and service consumed by a typical family.

Statement(B):Core inflation measures the change in average consumer Price Index certain items of volatile prices such as food and fuel.

of these Statement,

(a) Neither (A) nor (B) is correct.
(b) Both (A) and (B) are correct.
(C) Only (B) is correct.
(d) Only (A) is correct.

Correct Answer: (b) Both (A) and (B) are correct.

Solution:Headline inflation refers to the rate of change in the Consumer Price Index (CPI) Number, which represents the average cost of a standard basket of goods and services consumed by a typical household. Hence, statement (A) is correct.
Core inflation measures the change in average consumer prices after excluding from the CPI certain items of volatile prices such as food and fuel. Hence, statement (B) is also correct.

50. Core inflation is defined as : [U.P.P.C.S (Mains) 2017]

(a) Headline inflation excluding only fuel inflation.
(b) Food inflation and fuel inflation.
(C) Headline inflation excluding only food inflation.
(d) Headline inflation excluding both food inflation and fuel inflation.

Correct Answer: (d) Headline inflation excluding both food inflation and fuel inflation.

Solution:Core inflation represents the long run trend in the price level and in measuring long run inflation, transitory price changes should be excluded. Thus, core inflation is an inflation measure which excludes transitory or temporary price volatility as in the case of some commodities such as food items, fuel products etc. Hence, core inflation is defined as headline inflation excluding both food inflation and fuel inflation.