Passage Based Questions: Money and Banking | Economics Class 12 - Commerce PDF Download

Passage  - 1

Passage:
For an understanding of inflation, observing money supply growth as opposed to just reserve money growth, is very important. Milton Friedman said in 1970 that “inflation is always and everywhere a monetary phenomenon.” The pendulum has now swung to the other extreme. Today’s discussions on inflation make no reference to money. Neither extreme positions are valid.
The Old Quantity Theory of Money assumed that any increase in the quantity of money would have no effect on output (transactions). This is consistent with the classical view that money is a ‘veil’. Real magnitudes are affected only by real factors. But this view is no longer accepted. We need to understand that the process of money creation is a process of credit creation. The two go together.
In the process of money creation, credit goes either to the government or the business sector. Depending on the situation, money creation may have a greater effect on output or a greater impact on prices.
It is true that the focus of policy these days is more on price (interest rate) than quantity (money). But the two are interrelated. At
equilibrium, both the quantity and price are determined.
The monetary authority cannot, in effect, ‘order’ the interest rate. They need to adjust the quantity (money or liquidity) so that the desired level of interest rate is achieved. In fact, more recently since 2008, ‘Quantitative easing’ has become popular. There are occasions when quantity works better. (For a more elaborate analysis of the importance of quantity, see Rangarajan & Nachane, “Inflation, Monetary Policy and Monetary Aggregates”, Journal of Indian Public Policy Review, May 2021.)
The preceding discussion takes me to the main point that recent discussions on inflation in India in the Monetary Policy Statements tend to ignore money, even though there is reference to liquidity. The two (money and liquidity) are close but not identical, depending on what definition of liquidity one takes. Mainly the discussions center around the supply disruptions due to domestic or external factors. They do explain the behavior of individual prices but not the general price level, which is what inflation is about.
If inflation is to be kept under control, the authorities need to have control over liquidity or money. The critical question is what happens to demand, that is, demand in monetary terms. Thus, the quantity of liquidity or money is relevant. Analysts need to go beyond pointing out price movements of food articles or crude oil.
“Taking a closer look at money supply” – The Hindu Business Line – Oct, 31st 2021

Q1:  Explain the concept mentioned in the article.
Ans: Money Supply refers to the total amount of money available in an economy at a specific time. This includes:

• Currency: Physical notes and coins held by the public.
• Demand Deposits: Money held in bank accounts that can be withdrawn on demand.

The Reserve Bank of India (RBI) regulates the money supply through various measures, including:

• Controlling high-powered money.
• Adjusting the bank rate.
• Setting reserve requirements for banks.

Money supply is categorised into different measures:

• M1: Currency + Demand Deposits.
• M2: M1 + Savings deposits with Post Office banks.
• M3: M1 + Net time deposits of commercial banks.
• M4: M3 + Total deposits with Post Office savings organisations.

These categories reflect varying levels of liquidity, with M1 being the most liquid and M4 the least. 

Q2: How does the article describe the relationship between inflation and the concept mentioned?
Ans: When the money supply increases, prices typically rise due to a boost in demand within the economy. If the money supply grows faster than the increase in real output, it will lead to inflation.

Passage - 2

II. Read the following news article and answer the questions that follow:

Passage:
The Reserve Bank is likely to maintain the status quo on interest rates in its forthcoming monetary policy review but may change its stance in view of retail inflation piercing its upper tolerance limit, global uncertainties created by the ongoing Russia-Ukraine war, and the urgency to protect and boost growth, experts feel. The RBI Governor-headed rate-setting panel -- Monetary Policy Committee (MPC) -- will be holding its first meeting of the 2022-23 fiscal from April 6 to 8. The outcome will be announced on April 8.
Aditi Nayar, Chief Economist of ICRA Limited, said in the April 2022 policy review, the MPC is expected to revise up its Consumer Price Index-based inflation forecast, whereas the growth projections for 2022-23 would be pared. "Nevertheless, the MPC is unlikely to sacrifice growth to control imported inflation. With the upper threshold of the medium-term inflation target range being as high as 6 percent, the MPC is likely to remain growth supportive for longer than other central banks. Overall, we expect a status quo policy in April 2022," she said.
Given the current uncertainties, Suman Chowdhury, Chief Analytical Officer, Acuite Ratings & Research, opined that RBI "has limited scope to tighten monetary policy".
Amidst the deleterious impact of the war, the RBI will be walking a tightrope on its monetary policy decisions, striving to control inflation within the tolerance band while at the same time supporting nascent growth impulses, he said. "Going forward, we expect the RBI to restore the width of the LAF corridor to its pre-pandemic levels by hiking the reverse repo rate by 40 bps over the June-Aug 2022 policy review, followed by a cumulative 50 bps hike in the repo rate in the rest of 2022-23," Chowdhury said.
On the other hand, Dhruv Agarwala, Group CEO, Housing.com, Makaan.com & PropTiger.com, opined that given the increase in inflationary pressure due to the war in Ukraine, it will be difficult for the RBI to continue maintaining a status quo on key policy rates in its upcoming monetary policy. "While this would hurt the recovery process in India post the disruptions caused by the various waves of the coronavirus pandemic, the RBI may not have the flexibility to avoid a rate hike," he said.
Agarwala further said any upward tweak at this stage might have an impact on real estate as well, but the numbers for the March quarter show that the real estate sector is on a strong footing and may continue to cover the lost ground due to the pandemic on the back of strong pent-up demand.
RBI likely to maintain status quo on rates to support growth, say analysts – The Economic Times – Apr. 04, 2022

Q1:  Who is responsible for controlling monetary policy as per the article?
Ans: The Reserve Bank of India (RBI) manages the monetary policy in India through the Monetary Policy Committee. This committee is responsible for:

• Controlling the supply of money in the economy.
• Adjusting interest rates to influence economic activity.
• Implementing measures to ensure financial stability.

Through these actions, the RBI aims to maintain price stability and support economic growth. 

Q2: What rate adjustments are being discussed in the article?
Ans: The rate hikes being discussed may involve changes to the Repo rate set by the Reserve Bank of India (RBI).

Q3: What reasons does the article provide for the RBI's desire to maintain the status quo?
Ans: The RBI aims to maintain the status quo for several key reasons:

• To support economic growth.
• To ensure stability in the financial system.
• To manage inflation effectively.

Q4: Apart from adjusting rates, what other measures can the RBI use to control money supply?
Ans: The RBI can control the money supply using several measures, including:

• Cash Reserve Ratio (CRR): This is the percentage of deposits that banks must hold as reserves. Increasing the CRR reduces the amount of money banks can lend, thus decreasing the money supply.
• Statutory Liquidity Ratio (SLR): This requires banks to maintain a certain percentage of their net demand and time liabilities in liquid assets. A higher SLR limits the funds available for lending.
• Open Market Operations: The RBI buys or sells government bonds in the market. Buying bonds injects money into the economy, while selling them withdraws money from circulation.