Monetary Policy MCQs for UPSC Prelims

Correct answer: A - More liquidity in the market

Correct answer (a) More liquidity in the market. The Bank Rate is the rate at which the RBI lends to banks; lowering it makes central bank funds cheaper, encouraging banks to borrow and lend more, which increases liquidity in the system. (b) is the opposite effect, produced by raising the rate. (c) is wrong because a rate change does affect liquidity, and (d) is wrong because a lower Bank Rate eases credit rather than directly mobilising more deposits.

Correct answer: C - increase the investment expenditure in the economy

A decrease in the interest rate lowers the cost of borrowing, which encourages firms and individuals to invest more, so it increases investment expenditure. It tends to raise consumption rather than decrease it (a), does not directly increase tax collection (b), and lowers the return on savings, discouraging rather than increasing total savings (d). Hence it increases investment expenditure.

Correct answer: C - 1 and 3

When the central bank buys government securities from the public it injects money into the economy, and government borrowing from the central bank creates new money, so statements 1 and 3 increase money supply. Merely depositing existing currency in banks shifts the form of money without raising the total, and the central bank selling securities to the public absorbs money, so statements 2 and 4 do not increase supply. The answer is 1 and 3.

Correct answer: B - Increase in the banking habit of the population

The money multiplier rises when a larger share of money is deposited in and circulates through the banking system rather than being held as cash, so an increase in the banking habit of the population raises the multiplier. A higher cash reserve ratio or statutory liquidity ratio locks up more of banks' resources and reduces their capacity to create credit, lowering the multiplier. A mere rise in population does not by itself change the multiplier unless it alters deposit behaviour. Hence the increase in banking habit is correct.

Correct answer: C - Decreased money circulation helps in controlling the inflation

Decreased money circulation reduces demand-pull inflation, so option c is correct. Controlling inflation is a shared responsibility of both the government (fiscal measures) and the RBI (monetary measures), so saying it is the government's responsibility only (a) or that the RBI has no role (b) is wrong. Increased money circulation would worsen inflation, not control it, so option d is wrong.

Correct answer: D - 1, 2 and 3

As the bankers' bank the RBI holds the reserve deposits of commercial banks, acts as lender of last resort by lending to them in times of need, and guides them on monetary and banking policy, so all three statements are correct and the answer is 1, 2 and 3. Each of the narrower options drops a function that the RBI genuinely performs.

Correct answer: C - Scheduled Commercial Banks may cut their lending rates

The SLR is the share of net demand and time liabilities that banks must keep in liquid assets such as government securities. Cutting it by 50 basis points frees up resources that banks can lend, improving the supply of loanable funds and giving banks room to lower lending rates, so the third option is the likely outcome. A modest SLR cut works gradually and indirectly, so a drastic jump in GDP growth is an overstatement. FII flows respond to expected returns and risk perceptions, not directly to a reserve requirement tweak. The last option states the opposite effect, since an SLR cut adds liquidity rather than reducing it.

Correct answer: D - Central Bank is following a tight money policy

The Bank Rate is the rate at which the central bank lends to commercial banks, so raising it makes borrowing costlier, contracts credit and signals a tight money policy aimed at curbing inflation, making option (d) correct. A higher bank rate tends to push market interest rates up, not down, so option (a) is wrong. Option (b) is incorrect because raising the rate only makes such lending more expensive, it does not stop the central bank from lending. Option (c) is the opposite of the truth since an easy money policy involves lowering rates to expand credit.