money supply, banking & financial institutions section 1 Practice Questions Answers Test with Solutions & More Shortcuts

Answer: (d)

Seigniorage refers to the income from money creation. It is a way for governments to generate revenue without levying conventional taxes. Seigniorage is the profit that accrues to the central banks (which then may be transferred to the central government) in the following ways:

While issuing currency, the reserves/backup that the RBI keeps with itself, these reserves give RBI interest Income on the total amount of currency in circulation (minus cost of printing currency)

Interest accruing from bank balances with central banks arises from funds banks have to hold with the central banks to meet their reserve requirements, either as interest-free balances (CRR) or at below-market interest rates. the inflation tax concept which is measured as the product of the inflation rate and

the monetary base. (Because of inflation, the currency note that the public is holding losses value which reduces the liability of RBI in real terms)

Answer: (a)

Suppose (Nominal) exchange rate is $1 = Rs. 60

Now if an Indian exporter exported a particular commodity (1 unit) in the international market whose price is $8,

then he will get $8 and after conversion in India, he will get ultimately Rs. 480.

But if the rupee is undervalued (means less valued) i.e. USD 1 = Rs. 64 then he can sell his product in the international market at a lesser price of $7.5 and can earn the same Rs. 480 after conversion.

(When a country devalues its currency, then exporters are able to sell their product in the international market at a lesser price without compromising their earnings.)

So, we also say that exporters become more competitive.

Answer: (b)

Inflation is an increase in the price of goods. It can be seen as a devaluation of the worth of money. A crucial feature of inflation is that price rises are sustained.

Once only an increase in the rate of, say, value-added tax, will immediately put up prices, but this does not represent inflation unless the indirect effects of the VAT rise have repercussions of prices in periods after the direct effects.

Accounts of the causes of inflation are numerous. The most popular arguments are that it is caused by excess demand in the economy (demand-pull inflation), that it is caused by high costs (cost-push inflation) and that it results from excessive increases in the money supply (monetarism).

Inflation affects all segments of the economy.

Answer: (c)

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.

In other words, inflation means a continuous decrease in the value of money due to the excess supply of money in the market. There are two types of inflation demand-pull and cost-push inflation.

Causes behind inflation are reduced taxes, rate decrease in saving, increase in the supply of goods, increase in the number of producers in the market.

To control inflation there should be an increase in the tax rate and an increase in the interest rate.

Answer: (d)

The price of a product depends on its cost of production and its demand in the market both. If cost of production increases then the price of the product will increase and if cost of production does not increase but if demand increases then also price will increase because suppliers will sell at a higher rate. Apply the same logic for this question. The product here is money/rupee.

The lending rate in the economy may remain high, in spite of RBI reducing the repo rate because, banks may be offering higher deposit rates to the public, which is basically the cost of money for banks.

When Government offers a higher interest rate on its savings schemes then banks are not willing to reduce their own deposit rate, as they fear that they will lose depositors. When banks don’t reduce the deposit rates, they do not reduce the lending rates.

If there is a liquidity crunch in the economy i.e. there is more demand for money than the supply then the suppliers of money i.e. banks may not reduce the lending rate (the price of money) in spite of RBI reducing the repo rate.