[Mission 2024] STATIC QUIZ, 30 November 2023 – Economy

Solution: b)

Statement 3 is incorrect.

For any financial year, the two main variables of national income are GDP and GVA (or Gross Value Added). The GDP calculates India’s national income by adding up all the expenditures in the economy while the GVA calculates the national income from the supply side by looking at the value-added in each sector of the economy.

While both the variables measure national income, they are linked as follows:

GDP = (GVA) + (Taxes earned by the government) — (Subsidies provided by the government).

As such, if the government earned more from taxes than what it spent on subsidies, GDP will be higher than GVA. If, on the other hand, the government provided subsidies in excess of its tax revenues, the absolute level of GVA would be higher than the absolute level of GDP.

Solution: a)

Only statement 1 is correct.

Inflation redistributes wealth from creditors to debtors, i.e., lenders suffer and borrowers benefit out of inflation. The opposite effect takes place when inflation falls (i.e., deflation).

With every inflation the currency of the economy depreciates (loses its exchange value in front of a foreign currency) provided it follows the flexible currency regime.

Holding money does not remain an intelligent economic decision (because money loses value with every increase in inflation).

Solution: a)

Only Statement 2 is correct.

• Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act.
• 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 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.
• In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
• The amended RBI Act also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years.
• Prior to the amendment in the RBI Act in May 2016, the flexible inflation targeting framework was governed by an Agreement on Monetary Policy Framework between the Government and the Reserve Bank of India of February 20, 2015.

Solution: b)

Statement 3 is incorrect.

Repo Rate: The interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).

Reverse Repo Rate: The interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.

Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.

Solution: b)

While counter-cyclical fiscal policy is necessary to smooth out economic cycles, it becomes

critical during an economic crisis.

Relevance of Counter-cyclical Fiscal Policy:

Indian Kings used to build palaces during famines and droughts to provide employment and improve the economic fortunes of the private sector. Economic theory, in effect, makes the same recommendation: in a recessionary year, Government must spend more than during expansionary times. Such counter-cyclical fiscal policy stabilizes the business cycle by being contractionary (reduce spending/increase taxes) in good times and expansionary (increase spending/reduce taxes) in bad times. On the other hand, a pro-cyclical fiscal policy is the one wherein fiscal policy reinforces the business cycle by being expansionary during good times and contractionary during recessions.