Worksheet Solutions: Money and Banking- 1 | Economics Class 12 - Commerce PDF Download

Multiple Choice Questions (MCQs)

Case Study - 2

Q1: Read the following case study paragraph carefully and answer the questions on the basis of the same.
Ans: The Reserve Bank of India raised inflation forecasts on the back of higher oil and other raw materials while it maintained the growth forecast at 9.5% for FY22 despite anemic investment demand. Governor Shaktikanta Das said inflation measured by the consumer price index (CPI) might remain close to the upper tolerance band of 6% up to September expecting easing of pressure thereafter on kharif harvest arrivals. [RBI has fixed inflation rate target in between 2%-6 %.] The central bank projected CPI at 5.7% for FY22 compared to its earlier projection of 5.1%. “The supply-side drivers could be transitory while demand-pull pressures remain inert, given the slack in the economy. A pre-emptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions,” Das said.
Crude oil prices are volatile with implications for imported cost pressures on inflation, RBI said. “The combination of elevated prices of industrial raw materials, high pump prices of petrol and diesel with their second-round effects, and logistics costs continue to impinge adversely on cost conditions for manufacturing and services, although weak demand conditions are tempering the pass-through to output prices and core inflation

Q2: How does RBI promote growth process of country:-
(a) By controlling price level in country
(b) By changing various interest rates and money supply
(c) By increasing supply of products
(d) All of above
Ans: b

Q3: Why does RBI fix the inflation target?
(a) To make growth process fast
(b) To make coordination with government
(c) To manage exchange rate
(d) To stabilize economy
Ans: d

Q4: Why increasing crude oil prices are matter of concern :-
(a) Increasing crude oil prices are increasing transportation cost
(b) Increasing crude oil prices are making economy potentially unstable
(c) Increasing crude oil prices are volatising growth process
(d) Increasing crude oil prices are adversely affecting demand
Ans: b

Q5: What is money multiplier?
Ans: It refers to measurement of total money created by the banks in the form of deposits from each unit of initial deposits.
Money Multiplier=1/LRR

Q6: What is central bank?
Ans: It refers to that apex institute which controls, operates, regulates and develops monetary and banking structure of the economy. In India, it is known as Reserve Bank of India. It was established on 1st April, 1935.

Q7: Explain various functions of central bank.
Ans: Functions of central bank:

• Bank of Issue: Central bank has given sole monopoly power to issue the currency (except one-rupee notes and coins in India as it is issued by government of India) with the objective to control over the volume of money supply and credit in the economy.
  The currency issued by the central bank circulates in the economy as a legal tender money.
  Central bank has to maintain the reserves of gold and foreign exchange against the notes issued by it as per the statutory rules.
• Banker to the government: Central bank act as a banker to the government i.e. both state and central governments. All banking business of the government are carried out by the central bank.
  Government has the current account with the central bank, therefore, central bank accepts receipts and makes payment on behalf of the government.
  It also manages all public debts of the country. Whenever government has excess budgetary expenditure and needs loan then central bank also provides short term loans to government.
• Banker’s bank: There are hundreds of banks in an economy, so there should be some authority to regulate and supervises their functioning and this duty is assigned to the central bank.
  Central bank act as a banker’s bank in the following ways: 
  • Custodian of cash reserves: Central bank is the holder of minimum cash reserves of commercial banks as every bank must keep a minimum proportion of total deposits with central bank in the form of reserves.
  • Lender of last resort: Whenever banks are short of funds and fails to meet their financial obligation from any other source, then central bank at last provides loans and advances against discounting approved securities and bills of exchange, it is known as lender of last resort.
  • Clearing house function: Central bank holds cash reserves of commercial banks. So, it becomes easier for it to use clearing house function. All banks have their accounts with the central bank, thus central bank can easily settle the claims of various commercial banks by making debit and credit entries in their accounts.
• Controller of money supply and credit: Central bank not only issue the currency but also has given responsibility to control money supply and credit in the economy with the objective to maintain the price stability in the economy. For this, central bank uses monetary policy which has following instruments: –
  • Quantitative instruments: These instruments are used to control the total volume of credit in the economy. It includes bank rate, open market operatives, cash reserve ratio and statutory liquidity ratio, repo rate and reverse repo rate.
  • Qualitative instruments: These instruments are used to affect direction of credit in economy. It includes moral suasion, marginal requirements and selective credit rationing.
• Custodian of foreign exchange reserves: Central bank act as a custodian of nation’s gold and foreign exchange reserves with the objective to stabilise external value of domestic currency. All transactions of foreign currency are routed through RBI. If a person receives foreign exchange then he has to deposit it with the central bank.
  Similarly, if a person needs foreign exchange to make payment in abroad, then he has to supply with the central bank.

Q8: Explain various tools of monetary policy to control credit in the economy.
Ans: The policy used by central bank to control the money supply and credit in the economy is called monetary policy.
It includes following tools: –
Quantitative Tools
(a) Bank Rate: It is the rate at which central bank lends money to commercial banks to meet their long-term needs.
(i) If central bank increases bank rate, it will further increase rate of interest by commercial banks, thus cost of borrowings will increase which discourage people to borrow from banks and lead to contraction of credit.
(ii) If central bank decreases bank rate, it will further decrease rate of interest by commercial banks, thus cost of borrowings will decrease which encourage people to borrow from banks and lead to expansion of credit.
(b) Open Market Operations: It refers to buying and selling of government securities by the central bank in the open market from and to public and commercial banks.
(i) If central bank sells government securities in the open market, then it will reduce bank deposits, so capacity of banks to offer credit will decrease and lead to contraction of credit.
(ii) If central bank purchases government securities in the open market, then it will increase bank deposits, so capacity of banks to offer credit will increase and lead to expansion of credit.
(c) Cash Reserve Ratio (CRR): It refers to that minimum percentage of total deposits which a bank must keep with the central bank in the form of reserves.
(i) If central bank increases CRR, it means bank has to now keep more proportion of deposits with the central bank, then thus availability of funds with the bank for credit will decrease and will lead to contraction of credit.
(ii) If central bank decreases CRR, it means bank has to now keep less proportion of deposits with the central bank, then thus availability of funds with the bank for credit will increase and will lead to expansion of credit.
(d) Statutory Liquidity Ratio (SLR): It refers to that minimum percentage of total deposits which a bank has to keep with itself in the form of liquid assets.
(i) If central bank increases SLR, it means bank has to now keep more proportion of deposits with itself, thus capacity of banks to offer credit will decrease and lead to contraction of credit.
(ii) If central bank decreases SLR, it means bank has to now keep less proportion of deposits with itself, thus capacity of banks to offer credit will increase and lead to expansion of credit.
(e) Repo Rate: It is the rate at which central bank leads money to commercial banks to meet their short-term needs. The central bank provides short-term loans by discounting approved securities and bills of exchange.
(i) If central bank increase repo rate, it will further increase rate of interest by commercial banks, thus cost of borrowings will decrease which discourage people to borrow from banks and lead to contraction of credit.
(ii) If central bank decrease repo rate, it will further decrease rate of interest by commercial banks, thus cost of borrowings will increase which encourage people to borrow from banks and lead to expansion of credit.
(f) Reverse Repo Rate: It is the rate at which central bank borrows from commercial banks.
(i) If central bank increases reverse repo rate, it includes banks to transfer the funds to the RBI in the attraction of higher rate of interest, thus, capacity of banks to offer credit to public will decrease and lead to contraction of credit.
(ii) If central bank decreases reverse repo rate, it includes banks to transfer the funds to the RBI because of lower rate of interest, thus, capacity of banks to offer credit to public will increase and lead to expansion of credit.
Qualitative Tools
(a) Marginal requirements: It is the difference between market value of securities offered and amount of loan sanctioned.
(i) If central bank increases marginal requirements, so less credit will be offered against the security by the banks and lead to contraction of credit.
(ii) If central bank decreases marginal requirements, so more credit will be offered against the security by the banks and lead to expansion of credit.
(b) Moral suasion: It is the method adopted by central bank to persuade or convince commercial banks in order to advance the loans in accordance with direction of central banks for expansion or contraction of credit.