Section A: Multiple Choice Questions (MCQs)

Q1. Which of the following is NOT a function of money?
Answer: (c) Means of production
Money serves as a medium of exchange, a store of value, and a standard of deferred payment, but it is not a means of production.

Q2. The Reserve Bank of India was established in the year:
Answer: (a) 1935

Q3. Which of the following instruments is NOT a part of monetary policy?
Answer: (c) Fiscal Deficit
Fiscal deficit is a fiscal policy tool, not a monetary policy instrument.

Q4. When the central bank increases the repo rate, it leads to:
Answer: (b) Decrease in the supply of money
A higher repo rate makes borrowing costlier for commercial banks, reducing the money supply.

Q5. Assertion (A): Commercial banks create money through the process of credit creation.
Reason (R): Banks can lend money only to the extent of their total reserves.
Answer: (c) Assertion (A) is true but Reason (R) is false.
Banks lend based on a fraction of their reserves, not the total reserves.

Q6. Statement 1: A higher Statutory Liquidity Ratio (SLR) increases the money supply in the economy.
Statement 2: Open Market Operations refer to the buying and selling of government securities by the RBI to regulate money supply.
Answer: (d) Statement 2 is true and Statement 1 false
A higher SLR actually reduces the money supply; Statement 2 correctly defines Open Market Operations.

Q7. Match the terms in Column A with their correct description in Column B.
Answer: (a) (i)-(A), (ii)-(B), (iii)-(C), (iv)-(D)
(i) CRR – Minimum reserves banks must maintain with RBI
(ii) Inflation – Increase in the general price level
(iii) M1 – Currency held by the public + demand deposits
(iv) Repo Rate – Rate at which RBI lends money to commercial banks

Section B: Short Answer Questions

Q9. Explain the role of the Reserve Bank of India as the controller of credit in the economy.
The Reserve Bank of India (RBI) controls credit in the economy through monetary policy tools such as the repo rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), and Open Market Operations. By adjusting these instruments, the RBI influences the amount of money banks can lend, thereby controlling inflation, stabilizing the currency, and ensuring economic stability. For example, raising the repo rate or CRR reduces the money supply and credit availability, while lowering them increases liquidity in the economy.

Q10. Differentiate between Money Multiplier and Credit Multiplier with suitable examples.

• Money Multiplier: Refers to how much the money supply increases with an initial increase in reserves.
  • It is calculated as:

                                                                     Money Multiplier= 1/ Reserve Ratio (SLR or CRR or LRR)

For example, with a reserve ratio of 10%, the money multiplier is 10, meaning ₹1 of reserves can support ₹10 of deposits.

• Credit Multiplier: Refers to the ability of banks to create credit based on their reserves. It considers that banks may keep excess reserves and customers may withdraw cash, so the actual credit created is usually less than the theoretical maximum.

The credit multiplier is always less than the money multiplier due to these leakage.

Section C: Long Answer Question / Case Study

Q11. Case Study: Central bank measures to control inflation

The government of a country observes a high inflation rate due to excessive money supply in the economy. The central bank decides to take certain measures to control inflation and stabilize the economy.

Based on the given information, answer the following questions:

(a) Two measures the central bank can take to control inflation:

• Raise policy interest rates (e.g., repo rate)
• Sell government securities in the open market (Open Market Operations)

(b) How these measures help stabilize the economy:

• Raising interest rates makes borrowing more expensive and saving more attractive, reducing consumer spending and investment, which lowers demand and helps bring down inflation.
• Selling government securities withdraws liquidity from the banking system, reducing the money supply and curbing inflationary pressures.

(c) Impact on borrowing and investment:

• Higher interest rates and tighter liquidity make loans costlier and less accessible, leading to a decline in borrowing and investment by businesses and individuals. This helps slow down the economy, reducing inflation but may also slow economic growth.