money supply, banking & financial institutions section 4 Practice Questions Answers Test with Solutions & More Shortcuts

Answer: (c)

An outward shift in the demand for money, other things being equal should lead to a higher interest rate but the same quantity of money. The supply will not increase but with more demand the price (the interest rate) should increase.

Answer: (a)

A central bank, reserve bank, or monetary authority is a public institution that manages a state’s currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries.

In contrast to a commercial bank, a central bank possesses a monopoly on increasing the nation’s monetary base, and usually also prints the national currency, which usually serves as the nation’s legal tender.

The primary function of a central bank is to manage the nation’s money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking sector during times of bank insolvency or financial crisis.

Central banks usually also have supervisory powers, intended to prevent bank runs and to reduce the risk that commercial banks and other financial institutions engage in reckless or fraudulent behaviour.

Answer: (b)

Repo Rate is the rate at which commercial banks borrow funds from RBI. A reduction in the repo rate will help banks to get money from the central bank at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.

A value of (0) for the Gini Coefficient in a country implies that there is perfect equality in the system. If the value is 1 then there is complete inequality in the country.

Answer: (d)

In India, any money you send overseas is subject to controls, as the government is wary of excessive outflows of foreign exchange draining its reserves and destabilising the rupee. But there has been an effort to gradually liberalise these controls.

The window that was opened up in 2004 for individuals to remit/send money across the border, without seeking specific approvals, was called the Liberalised Remittance Scheme (LRS).

Under LRS, all resident individuals (in India) can freely remit/send $250,000 overseas every financial year for a permissible set of current or capital account transactions.

Remittances are permitted for overseas education, travel, medical treatment and purchase of shares and property, apart from maintenance of relatives living abroad, gifting and donations. Individuals can also open, maintain and hold foreign currency accounts with overseas banks for carrying out transactions.

(Now anyone can say that “Rupee is fully convertible at current account” then what is this limit of $2,50,000? See, under this scheme, you can freely send the money abroad without specific government approvals, that is why the name is liberalized. But if you want to send more under current account then it may be possible but you may have to take specific approval of government which is not under this scheme)

However, the rules do not allow trading in “foreign exchange” (for example Dollar and Pound trading). Sending money to certain countries and entities is also barred. Under LRS, people can’t send money to countries identified as 'non-cooperative' by the Financial Action Task Force. Remittances are also prohibited to entities identified as posing terrorist risks.

The LRS represents India’s baby steps towards dismantling controls on foreign exchange movements in and out of the country. It has allowed large numbers of Indians to study abroad and diversify their portfolios from purely desi stocks and property.

Ideally speaking, capital controls in any form have no place in a liberalised economy. But for India, which is heavily dependent on imports of critical goods and perpetually spends more foreign exchange than it earns, it is difficult to free up remittances because of the havoc this can wreak on exchange rates.

The LRS gives you the freedom to put your money to work anywhere in the world. Until India is ready to free all capital controls, the LRS remains the most viable way for individuals to legally remit money overseas.

Answer: (b)

Devaluation in modern monetary policy is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged.

There are two implications for currency devaluation. First, devaluation makes a country’s exports relatively less expensive for foreigners and second, it makes foreign products relatively more expensive for domestic consumers, discouraging imports.

As a result, this may help to reduce a country’s trade deficit. Import substitution means the promotion of export to replace imports. It is also a fallout of devaluation.