money supply, banking & financial institutions section 8 Practice Questions Answers Test with Solutions & More Shortcuts

Answer: (d)

The four concepts of money used in calculating money supply are known as the money stock measures or measures of monetary aggregates.

These are M₁, M₂, M₃, M₄.

M₃ = M₁ + Term deposits with the bank.

Answer: (a)

Banks are mandated to keep only a fraction of the deposits as reserves, the rest they can lend and this lending creates money in the system.

For example, If I had Rs. 100 cash with me which I deposited in a bank, and say the bank kept Rs. 20 in reserves and rest i.e. Rs. 80 it lent to someone else.

Now, the money with me is Rs. 100 (in deposit form) and money with the other person is Rs. 80. So, now total money in the system is Rs. 180, while earlier it was only Rs. 100. And this became possible just because the person depositing the money in the bank and the bank kept only a fraction in the reserve and the rest is lent to someone else. This is called fractional reserve banking.

In the above case monetary base is Rs. 100 and money supply is Rs. 180

Money multiplier = Money Supply/Monetary Base =180/100 = 1.8

In another case, if I would have only Rs. 50, which I deposited in the bank and the bank kept 20% reserves i.e. Rs. 10 and the rest Rs. 40 it lent then, Money multiplier = 90/50 = 1.8

If banks are mandated to keep all the deposited money i.e. Rs. 100 as reserves then banks would not have lent and no new money would have been created in the system. And then; the Money multiplier would have been = 100/100 = 1

For a detailed understanding, you can refer to the book on Indian Economy by Vivek Singh.

Answer: (c)

Answer: (d)

Inflation occurs when too much money is chasing too few goods. The prevailing view in mainstream economics is that inflation is caused by the interaction of the supply of money with output and interest rates.

In general, mainstream economists divide into two camps:

1. those who believe that monetary effects dominate all others in setting the rate of inflation, or broadly speaking, monetarists, and
2. those who believe that the interaction of money, interest and output dominate over other effects, or broadly speaking Keynesians.

Other theories, such as those of the Austrian school of economics, believe that inflation of the general price level and of specific prices is a result of an increase in the supply of money by central banking authorities.

Answer: (b)

Stagflation describes a situation where an inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high.

It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment and vice versa.