Monetary Tools and Policies MCQ Quiz - Objective Question with Answer for Monetary Tools and Policies - Download Free PDF

The correct answer is Commercial banks will have less money to lend.

Key Points

• Cash Reserve Ratio (CRR) refers to the percentage of deposits banks have to keep as reserve (in cash). This reserve sum is not available for banks for lending and thus if the CRR increases, banks will have less money to lend.
  • As per RBI regulations, a portion of a bank’s total deposit has to be maintained with the RBI as reserves in the form of liquid cash. This portion is decided by the RBI. The higher the CRR, the lower the amount available for lending in the market.
  • CRR is used by RBI to control the flow of money in the economy. 

Additional Information

• CRR ensures transparency of a bank in borrowing and lending in the credit market. 
  • CRR is also used to control inflation. When the inflation is high, RBI increases the CRR hence the banks are left with a lesser amount of money that can be lent as loans. As a result, the money flow is decreased and inflation is brought down.
  • Cash Reserve Ratio was set as 4.5 % in Nov 2022.

The correct answer is Bank Rate.

Key Points

• Bank Rate: The Bank Rate is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks for long-term loans.
• The Bank Rate is a tool used by the RBI to control liquidity and inflation in the economy.
• It is different from the Repo Rate, which is used for short-term loans.
• Changes in the Bank Rate can influence the interest rates on loans and deposits in the banking system.
• A higher Bank Rate can lead to higher borrowing costs for banks, which may be passed on to customers in the form of higher interest rates on loans.

Additional Information

• Repo Rate:
  • The Repo Rate is the rate at which the RBI lends short-term money to commercial banks against securities.
  • It is used by the RBI to control inflation and manage the money supply in the economy.
  • A decrease in the Repo Rate can lead to lower borrowing costs for banks, which may reduce interest rates on loans for consumers.
• Reverse Repo Rate:
  • The Reverse Repo Rate is the rate at which the RBI borrows money from commercial banks.
  • It is used to absorb liquidity from the banking system.
  • An increase in the Reverse Repo Rate can encourage banks to park more funds with the RBI, reducing the money supply in the economy.
• Cash Reserve Ratio (CRR):
  • CRR is the percentage of a bank's total deposits that must be maintained with the RBI as reserves.
  • It is used by the RBI to control the amount of liquidity in the banking system.
  • Changes in the CRR can influence the amount of funds available for banks to lend.

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Credit control is done by RBI to maintain monetary stability in the economy. It is one of the main functions of RBI.

The main difference between the Qualitative and Quantitative method is that:

Quantitative Methods of monetary policy include those instruments which focus on the overall supply of money. It includes: 

A. Two Policy Rates: 

• Bank rate is the rate charged on the loans offered by the Central bank to the commercial banks without any collateral. It is increased at the time of inflation to reduce the money supply in the economy and vice versa. 
• Repo rate is the rate charged on the secured loans offered by the Central bank to the commercial banks that includes collateral. It is increased at the time of inflation to reduce the money supply in the economy and vice versa. 

B. Two Policy Ratio:

• Statutory Liquidity Ratio (SLR) refers to liquid assets that the commercial banks must hold on a daily basis as a percentage of their total deposits. SLR is determined by the central bank and is a legal requirement to be fulfilled by commercial banks.  It is increased at the time of inflation to reduce the money supply in the economy and vice versa. 
• Cash Reserves Ratio (CRR) refers to the proportion of total deposits of the commercial banks which they must have kept as cash reserves with the central bank. The ratio is fixed by the central bank and is varied from time to time to control the supply of money in the economy depending upon the prevailing situation of inflation or deflation.

C. Open Market Operations: 

• Open market operation (OMO) is a monetary policy by the central bank in which the bank deals in the sale and purchase of securities in the open market to control the supply of money in the economy. By selling the securities, the central bank soaks liquidity from the economy and by buying the securities, the central bank releases liquidity. 

2. Qualitative Methods of monetary policy includes those instruments which focus on the selected sectors of the economy. It includes: 

1. Margin Requirement
2. Rationing of Credit
3. Moral Suasion

Therefore, the Bank rate is Quantitative credit control weapon.

The Correct Answer is Option 2 i.e. RBI.

• Monetary policy is the macroeconomic policy laid down by the central bank.
• The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy.
• This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
• The RBI implements the monetary policy through open market operations, CRR, SLR, bank rate policy,  reserve system, credit control policy, moral persuasion etc.
• It is through the monetary policy, RBI controls inflation in the country.

The correct answer is CPI.

Key Points

• CPI stands for Consumer Price Index.
• The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
• It is most widely used to calculate inflation and to adjust income and cost of living increases for individuals, businesses, and government agencies.
• The CPI is calculated by the Bureau of Labor Statistics (BLS) and is released monthly.
• The market basket of goods and services used in the CPI includes food, housing, clothing, transportation, medical care, recreation, education, and communication.
• The CPI is often used as a benchmark for measuring price changes in the economy and is also used to adjust Social Security benefits and tax brackets.
• There are different CPI measures, including the CPI-U (for all urban consumers), the CPI-W (for urban wage earners and clerical workers), and the CPI-E (for the elderly).
• Changes in the CPI can affect interest rates, investment returns, and purchasing power.
• Formula for calculating CPI :
  • CPI = (Cost of market basket in given time / Cost of market in base time) x 100

Additional Information

•  WPI (Wholesale Price Index):
  - Measures the changes in the prices of goods at the wholesale level
  - Used to track inflation and deflation trends in some economies
  - Includes various commodity groups such as food, fuel, and manufactured goods
  - Provides an indication of the overall price movement in the economy
• National Income:
  - Total income earned by a country's residents and businesses in a given period
  - Includes income from wages, profits, and taxes
  - Used to measure a country's economic performance and standard of living
  - Calculated using various methods such as GDP, GNP, and NNP
• Per Capita Income:
  - Average income earned per person in a country
  - Calculated by dividing the total national income by the population
  - Used to measure the average standard of living in a country
  - Helps in comparing the economic well-being of different countries

The correct answer is Reverse Repo Rate.

Key Points

• The Reverse Repo Rate is the interest rate at which the Reserve Bank absorbs liquidity from banks against the collateral of eligible government securities under the LAF.
• It refers to the rate at which the central bank borrows money from commercial banks.
• When there is inflation government Increases the reverse repo rate to reduce the money supply and vice versa in case of deflation.
• It is one of the quantitative instruments of the central bank.
• It should always be kept in mind that, the reverse repo rate is always fixed below the repo rate.

Additional Information

The correct answer is RBI.

• The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
• Monetary policy refers to the use of monetary instruments under the control of the central bank to regulate magnitudes such as interest rates, money supply and availability of credit with a view to achieving the ultimate objective of economic policy.
• The Monetary Policy Committee (MPC) constituted by the Central Government under Section 45ZB determines the policy interest rate required to achieve the inflation target.
• The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.

The correct answer is Reserve Bank of India.

Key Points

• Bank Rate refers to the official interest rate at which RBI will provide loans to the banking system.
• Bank rate is used as a signal by the RBi to the commercial banks on RBI's thinking about what the interest rate should be.

Important Points

Monetary Tools of RBI:

Additional Information

The correct answer is the reverse repo rate.

• The rate at which the Reserve Bank of India takes loans from other banks is called the reverse repo rate.

Key Points

• Reverse Repo Rate:
  • It is the rate, at which banks park short-term excess liquidity with the RBI.
  • The current reverse repo rate is 3.35%

Additional Information

• Bank Rate:
  • It is also called the rediscount rate.
  • It is the rate, at which the RBI gives finance to commercial banks.
• Cash Reserve Ratio (CRR):
  • The RBI (Amendment) Bill, 2006, empowers RBI to prescribe CRR–Cash that banks deposit with the RBI without any floor rate or ceiling rate.
  • The current CRR rate is 4.5%.
• Statutory Liquidity Ratio (SLR):
  • It is the ratio of liquid assets, which all commercial banks have to keep in the form of cash, gold, and unencumbered approved securities equal to not more than 40% of their total demand and time deposit liabilities (ranges is 25‑40%).
  • The current SLR is 18.00%.
• ​Repo Rate:
  • It is the rate, at which RBI lends short-term money to the bank against securities.
• Open Market Operations (OMOs):
  • Under OMOs, the RBI sells G-securities in the market.

The correct answer is Repo Rate.

Key Points

• Repo Rate is the rate at which the Reserve Bank Of India lends money to commercial banks in India if they face a scarcity of funds.
• Current Repo Rate: 6.50 %.
• It is a rate on short-term, collateral-backed borrowing.
• The Repo rate is used by monetary authorities to control inflation.

Reverse Repo Rate

• It is the rate at which the Reverse Bank of India borrows funds from commercial banks.
• It is the rate at which commercial banks in India deposit their excess money with the Reserve Bank of India usually for the short term.
• Current Reverse Repo Rate: 3.35%.

Sovereign Rate

• It is similar to the corporate bond credit ratings.
• It is based upon an assessment of both the ability and willingness of a country to service its debt.

Prime Lending Rate

• It is an interest rate used by the banks at which banks lend to customers with good credit.

The correct answer is 1996.

Key Points

• In 1996, the Government of India set up a Disinvestment Commission under the Ministry of Industries.
• The mandate of the commission was to assess the viability and advice the Government on disinvesting various PSE's through market development and diversifying transfer of ownership of the PSU's for five-ten years period.
• Ministry of Industry (Department of Public Enterprises) vide a resolution dated 23 August 1996, constituted a Public Sector Disinvestment Commission for a period of three years under Shri G.V. Ramakrishna along with four other members.
• The term was further extended till 30 November 1999.
• The Commission submitted reports on 58 PSEs. 

Repo rate is the rate at which the central bank of a country (Reserve Bank of India in the case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.

In the event of inflation, central banks increase the repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.

Thus, option 3 is the correct answer.

Reverse Repo Rate is when the RBI borrows money from banks when there is excess liquidity in the market. The banks benefit from it by receiving interest for their holdings with the central bank.

During high levels of inflation in the economy, the RBI increases the reverse repo. It encourages the banks to park more funds with the RBI to earn higher returns on excess funds. Banks are left with lesser funds to extend loans and borrowings to consumers.

The correct answer is Budget expenditure- Budget receipts excluding borrowings.

Key Points

• Fiscal Deficit is the difference between the total income of the government (total taxes and non-debt capital receipts) and its total expenditure. While calculating the total revenue, borrowings are not included. Hence, Fiscal Deficit is- Budget expenditure- Budget receipts excluding borrowings.
  • A fiscal deficit situation occurs when the government’s expenditure exceeds its income. This difference is calculated both in absolute terms and also as a percentage of the Gross Domestic Product (GDP) of the country. A recurring high fiscal deficit means that the government has been spending beyond its means.
  • The government describes fiscal deficit of India as “the excess of total disbursements from the Consolidated Fund of India, excluding repayment of the debt, over total receipts into the Fund (excluding the debt receipts) during a financial year”.

Important Points

• What constitutes the government’s total income or receipts?
  • It has two components revenue receipts and non-tax revenues.
    • Revenue receipts of the government
      • Corporation Tax
      • Income Tax
      • Custom Duties
      • Union Excise Duties
      • GST and taxes of Union territories.
    • Non-tax revenues
      • Interest Receipts
      • Dividends and Profits
      • External Grants
      • Other non-tax revenues
      • Receipts of union territories
• Expenditures of the government:
  • Revenue Expenditure
  • Capital Expenditure
  • Interest Payments
  • Grants-in-aid for creation of capital assets

Key Points

• Fiscal Deficit formula: 
  • Fiscal Deficit = Total expenditure of the government (capital and revenue expenditure) – Total income of the government (Revenue receipts + recovery of loans + other receipts)
  • If the total expenditure of the government exceeds its total revenue and non-revenue receipts in a financial year, then that gap is the fiscal deficit for the financial year. 
  • The government meets fiscal deficit by borrowing money. In a way, the total borrowing requirements of the government in a financial year is equal to the fiscal deficit in that year. 

The correct answer is base rate

Key Points

• The Base Rate is the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is the minimum interest rate of a bank below which it is not viable to lend.

Additional Information Prime Lending Rate:

• It is the interest rate that commercial banks normally charge (or we can say they were expected to charge) their most credit-worthy customers.
• The Base Rate is the minimum interest rate of a Bank below which it cannot lend, except in cases allowed by RBI. The base rate system has replaced the BPLR system with effect from July 1, 2010.

Deposit rate

• The deposit interest rate is the percentage of profit you earn on your money in an interest-bearing account with a financial institution.
• The interest rate offered by banks and other financial institutions on deposits can vary depending on the type of deposit account, the amount of deposit, and the tenure of the deposit

Bank rate

• The bank rate is the rate of interest at which a central bank lends money to commercial banks, usually in the form of long-term loans.
• The Reserve Bank of India (RBI) is the central bank of India and determines the bank rate in India.
• The bank rate is used by the central bank to control the money supply in the economy and influence economic activity.
• The bank rate is usually higher than the repo rate on account of its ability to regulate liquidity

The correct answer is Open Market Operations.

Key Points

• Open market operations (OMO) refer to a central bank's buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system.
• Securities purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and contract the economy.
• RBI carries out the OMO through commercial banks and does not directly deal with the public.
• OMO is one of the tools that RBI uses to smoothen the liquidity conditions throughout the year and minimize its impact on the interest rate and inflation rate levels.

Additional Information

• RBI was founded on 1 April 1935, in Kolkata.
  • HQ in Mumbai.
  • Present Governor is Sanjay Malhotra.
  • The RBI is responsible for implementing monetary and credit policies, issuing currency notes, being a banker to the government, a regulator of the banking system, manager of foreign exchange, and regulator of payment & settlement systems while continuously working towards the development of Indian financial markets.
  • RBI is not a Commercial Bank.
  • RBI was nationalized on 1st January 1949.