Money And Banking - 2 - UPSC Indian Economy Free MCQ Test with solutions

The Reserve Bank of India (RBI) today gave freedom to banks in deciding their base rate. “Banks may choose any benchmark to arrive at the base rate for a specific tenor that may be disclosed transparently,” RBI said, as it released the final guidelines this evening.

Open market operations (OMO) refer to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system. Securities' purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and contract the economy. The Federal Reserve (Fed) facilitates this process and uses this technique to adjust and manipulate the federal funds rate, which is the rate at which banks borrow reserves from one another.

Answer:

Introduction:

A: Flat money

B: Legal tenders

C: Fiat money

D: Both b and c

Explanation:

1. Flat Money:

Flat money refers to currency notes and coins that have value because the government declares them as legal tender. However, the term "flat money" is not commonly used and might not accurately describe currency notes and coins.

2. Legal Tenders:

Legal tenders are currency notes and coins that are recognized by law as a means of payment. They must be accepted by creditors as payment of debts. Legal tenders are issued by the government or central bank and are widely accepted within the country. Examples of legal tenders include the US dollar, Euro, British pound, etc.

3. Fiat Money:

Fiat money is a type of currency that has value because the government declares it as legal tender, but it is not backed by a physical commodity such as gold or silver. The value of fiat money is based on the trust and confidence of the people using it. Most modern currencies, including currency notes and coins, are examples of fiat money.

4. Both B and C:

The correct answer is option D, "Both b and c." Currency notes and coins are both legal tenders and fiat money. They are recognized by law as a means of payment and derive their value from the government's declaration.

Conclusion:

Currency notes and coins are commonly referred to as legal tenders and fiat money. They serve as a medium of exchange and are recognized by law as a means of payment. It is important to use and handle them responsibly to maintain the stability of the monetary system.

What is the currency deposit ratio (cdr)?

The currency deposit ratio (cdr) is a financial ratio that measures the proportion of money held by the public in currency to that held in bank deposits. It is used to analyze the preference of individuals and businesses to hold cash versus depositing it in banks.

Explanation:

When answering this question, it is important to provide a detailed explanation of the currency deposit ratio (cdr) and its components. Here is a breakdown of the answer:

The correct option is Option A. 

If Reserve Bank of India wants to decrease the money supply in order to check inflation then they will use the quantitative measures of their monetary policy which includes: 

(i) Selling bonds in open market: Open market operation (OMO) is a monetary policy by the central bank in which the bank deals in the sale and purchase of securities and bonds in the open market to control the supply of money in the economy. By selling the securities and bonds, the central bank soaks liquidity from the economy that reduces the purchasing power in the economy which controls the situation of inflation.  

(ii) Increase in CCR: Cash Reserves Ratio (CRR) refers to the proportion of total deposits of the commercial banks which they must keep as reserves with the central bank in the form of cash. By increasing the cash reserve ratio, the commercial banks has to maintain more cash with the central bank which  reduces their credit creation capacity and therefore money supply in the economy also reduces which corrects the situation of inflation.

(iii) Hiking bank rate: Bank rate is the rate charged on the loans offered by the Central bank to the commercial banks without any collateral. Bank rate is a quantitative credit control measure under the monetary policy of the government as it controls the overall supply of the money in the economy. During inflation, bank rate is increased to reduce the total money supply in the economy by reducing the amount of credit creation by the commercial banks.

The services administered by 
government and paid for collectively through taxation are known as public goods. 

Examples of public goods are National defense, Roads, National forests. 

But, if we talk about cars, they are the mixed public goods.

M2 is a calculation of the money supply that includes all elements of M1 as well as "near money." M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits.

One of the types of deposit accounts offered by commercial banks is a savings account. A savings account is a popular choice for individuals to deposit their money and earn interest on their savings.

Here are some key points about savings accounts:

• Savings accounts allow individuals to deposit their money with a bank and earn interest on their savings.


• The interest rates offered on savings accounts may vary from bank to bank.


• Savings accounts provide a safe and secure way to store money.


• Individuals can access their savings accounts and withdraw money as needed.


• Some savings accounts may have minimum balance requirements.


• Savings accounts may offer additional features like online banking and ATM access.


• Interest earned on savings accounts is typically taxable.


• Savings accounts are often used by individuals to save for short-term goals or emergencies.

It is important to note that while savings accounts provide a safe and convenient way to store money, the interest rates offered on savings accounts are generally lower compared to other investment options. Therefore, individuals looking for higher returns may opt for other types of investment accounts like mutual funds or share holdings.

• The barter system was an ancient method of exchanging goods and services without the use of money.


• Under the barter system, individuals directly traded their goods or services for other goods or services they needed.


• However, the barter system had several limitations:




• Lack of a common measure of value: It was difficult to determine the value of different goods and services in terms of each other.


• Double coincidence of wants: Both parties had to have a mutual desire for each other's goods or services, which made direct exchanges less likely.


• Lack of divisibility: Some goods or services were not easily divisible, making it challenging to exchange them for smaller items.




• The monetary system, on the other hand, replaced the barter system and introduced the use of money as a medium of exchange.


• Money serves as a common measure of value, making it easier to compare the worth of different goods and services.


• With the introduction of money, individuals can exchange their goods or services for money and use that money to acquire other goods or services they desire.


• The monetary system also overcomes the limitations of the barter system:




• Money eliminates the need for a double coincidence of wants as individuals can sell their goods or services for money, which can be used to purchase any other goods or services.


• Money is divisible, allowing for more flexible exchanges and transactions.

Therefore, the barter system has been replaced by the monetary system, where money is used as a medium of exchange, making transactions more efficient and convenient.

Cash Reserve Ratio is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves with the central bank.

Cash Reserves Ratio (CRR) refers to the proportion of total deposit of the commercial banks which they must keep as reserves with the central bank in the form of cash deposits. In other words, these are the cash deposits of commercial banks with the central bank which they have to deposit as a legal requirement with central bank. The ratio is fixed by the central bank and is varied from time to time to control the supply of money in the economy depending upon the prevailing situation of inflation or deflation.

The fraction of deposits that commercial banks are required to keep as cash reserves is called the Cash Reserve Ratio (CRR).

CRR (Cash Reserve Ratio): This is the percentage of a bank's total deposits that must be kept in the form of reserves with the central bank (e.g., Reserve Bank of India in India). This helps ensure that banks maintain liquidity and can meet their withdrawal obligations.

The other options:

• LRR (Legal Reserve Ratio): This term is sometimes used interchangeably with CRR but generally refers to the total reserves that a bank must hold, which can include both cash and other forms of reserves. It’s not a commonly used term in modern banking compared to CRR.
• SLR (Statutory Liquidity Ratio): This refers to the minimum percentage of a commercial bank's net demand and time liabilities (NDTL) that it must maintain in the form of liquid assets like cash, gold, or government securities. This is different from CRR, which is specifically about cash reserves.
• PLR (Prime Lending Rate): This is the rate at which commercial banks lend to their most creditworthy customers. It is unrelated to reserve requirements.

• The MPC is a statutory body established under the Reserve Bank of India Act, 1934.
• It consists of six members, with the RBI Governor as the ex-officio Chairperson.
• Each member has one vote; in case of a tie, the RBI Governor has the casting vote.
• Decisions are made by a two-thirds majority of the members present and voting.

Out of these statements, only three are correct.