Monetary Policy & RBI Tools — Set 18

Correct Answer: B. Money multiplier decreases

The money multiplier is approximately equal to 1/CRR (in a simplified model). When RBI raises the CRR, a larger proportion of deposits must be held as reserves, reducing the amount available for lending. This decreases the money multiplier — meaning each unit of reserve money creates less broad money in the economy, contracting money supply.

Correct Answer: B. The interest rate range from the reverse repo rate (floor) to the MSF rate (ceiling)

The repo corridor is the interest rate band formed by the reverse repo rate (or SDF rate as the effective floor) at the bottom and the MSF rate at the top, with the policy repo rate in the middle. The corridor structure ensures short-term money market rates are anchored within this range. A narrower corridor means tighter control over market interest rate volatility.

Correct Answer: B. Credit extended by banks excluding food credit — indicator of overall economic credit demand

Non-food credit refers to total bank credit excluding credit extended for food procurement (like food credit to Food Corporation of India for procuring grains). RBI monitors non-food credit growth as a key indicator of overall economic activity, investment demand, and the effectiveness of monetary policy transmission. Sluggish non-food credit growth despite rate cuts signals poor transmission.

Correct Answer: B. Auctions where banks bid to park excess funds with RBI at variable interest rates

Variable Rate Reverse Repo (VRRR) is a liquidity absorption tool used by RBI where banks can park their excess liquidity through an auction process at variable interest rates. Unlike the fixed rate reverse repo, VRRR is conducted through auctions where the cut-off rate is market-determined. RBI increased reliance on VRRR from 2021 to gradually normalise excess liquidity without formal rate hikes.

Correct Answer: B. RBI transfers its annual profit (surplus) to government, impacting fiscal calculations

The RBI transfers its annual surplus (profits after provisions and reserves) to the Government of India, which counts as non-tax revenue for the government. The Bimal Jalan Committee (2019) established a framework for determining the size of RBI's economic capital and the surplus transferable to government. In 2024, RBI transferred a record ₹2.11 lakh crore to the government.

Correct Answer: B. Maintaining a low and stable rate of inflation conducive to sustainable growth

Price stability, as an objective of monetary policy, does not mean zero inflation — it means maintaining a low, stable, and predictable rate of inflation. In India's framework, this is the 4% CPI target (±2%). Price stability creates a predictable economic environment, protects purchasing power of money, encourages savings and investment, and supports long-term growth.

Correct Answer: B. High government borrowing pushes up interest rates, reducing private investment

Crowding out occurs when the government borrows heavily in the financial market to fund its fiscal deficit, pushing up interest rates. Higher interest rates increase the cost of capital for private businesses, reducing private investment. This is a key concern in monetary-fiscal coordination: large fiscal deficits can crowd out private investment and undermine the effectiveness of monetary easing.

Correct Answer: B. If India has higher inflation than trade partners, rupee tends to depreciate (PPP concept)

The inflation differential between India and its trading partners is a key determinant of the exchange rate under the Purchasing Power Parity (PPP) theory. If India's inflation is consistently higher than its partners, the rupee tends to depreciate over time to maintain purchasing power parity. This is why RBI's success in controlling domestic inflation also helps limit rupee depreciation.

Correct Answer: B. Reviewing RBI's economic capital framework and surplus transfer norms

The Expert Committee on RBI's Economic Capital Framework, chaired by former RBI Governor Dr. Bimal Jalan (2018-19), examined how much capital RBI needs to hold for contingency purposes and how much surplus can be transferred to the government. The committee recommended maintaining a Contingency Risk Buffer (CRB) of 5.5% to 6.5% of RBI's balance sheet, with excess transferred to government.

Correct Answer: C. Money market regulated by RBI; capital market by SEBI — both equal in importance

The money market deals with short-term instruments (maturity up to 1 year) like treasury bills, call money, commercial paper, and certificates of deposit — regulated by RBI. The capital market deals with long-term instruments like equity and bonds — regulated by SEBI. Both are important for monetary policy: RBI's LAF operations occur in the money market, while OMOs and G-SAP affect the government securities (capital) market.