UPSC Prelims 2023 Q22: Indian Economy – Monetary Policy & Money Supply
- (a) Both Statement - I and Statement - II are correct and Statement - II is the correct explanation for Statement - I
- (b) Both Statement - I and Statement - II are correct and Statement - II is not the correct explanation for Statement - I
- (c) Statement - I is correct but Statement - II is incorrect
- (d) Statement - I is incorrect but Statement - II is correct
Answer: (a) Both Statement - I and Statement - II are correct and Statement - II is the correct explanation for Statement - I
Explanation
Post-pandemic interest rate hikes
| Central bank | Policy rate move (2022–23) |
|---|---|
| US Federal Reserve | Raised rates from near 0% to 5.25–5.5% |
| European Central Bank | First hikes in over a decade; deposit rate to 4% |
| Bank of England | Raised to 5.25% |
| Reserve Bank of India | Raised the repo rate by 250 basis points, from 4% to 6.5% |
Statement I — correct. Many central banks raised rates sharply after the pandemic.
Statement II — correct, and it explains I. Central banks believe monetary tightening can control inflation.
How a rate hike fights inflation:
| Step | Effect |
|---|---|
| Higher policy rate | Loans become costlier |
| Less borrowing and spending | Demand cools |
| Lower demand | Price rises slow down |
Answer: (a) Both Statement - I and Statement - II are correct and Statement - II is the correct explanation for Statement - I.
Why each option is right or wrong
- (a) CORRECT. Central banks raised rates because they believe monetary policy can curb rising prices.
- (b) Incorrect. Statement II is the reason for the hikes, so it does explain Statement I.
- (c) Incorrect. Statement II is true; inflation control is the core aim of monetary policy.
- (d) Incorrect. Statement I is true; 2022–23 saw the fastest global tightening in decades.
Key point
After COVID, inflation surged; central banks (Fed, ECB, RBI) raised rates because they trust monetary policy to curb prices.
Remember
Central banks raised rates after the pandemic to fight inflation.
Common mistakes
- Choosing (b) without checking the cause: the hikes happened because of this belief.
- Thinking rate hikes increase inflation; they reduce demand and so ease inflation.
- Forgetting the RBI's flexible inflation target of 4% ± 2%.
Exam tip
Use 'because' to test I/II links: 'Central banks hiked rates because they think they can fight inflation' — true.
Sources
- RBI — Monetary Policy Statements (2022–23)
- NCERT Class XII — Introductory Macroeconomics, Ch 3 (Money and Banking)