CA Foundation Economics – Measures of Money Supply in India Multiple Choice Questions

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The Concept of Money Supply Introduction

Question 1. What is the concept of “money supply” in economics?

  1. The total amount of money held by an individual or household.
  2. The total amount of money in circulation within an economy at a specific point in time.
  3. The total amount of money that a government can print to finance its expenditures.
  4. The total amount of money invested in financial assets, such as stocks and bonds.

Answer: 2. The total amount of money in circulation within an economy at a specific point in time.

Explanation:

The concept of money supply refers to the total amount of money available in an economy, including currency notes, coins, and various forms of bank deposits, that is in circulation at a given moment.

Question 2. Which of the following is considered “M1” in the classification of money supply?

  1. Currency held by the public and demand deposits with banks.
  2. Currency held by the public and time deposits with banks.
  3. Currency held by the public, time deposits with banks, and savings deposits.
  4. Currency held by the public, demand deposits with banks, and time deposits.

Answer: 1. Currency held by the public and demand deposits with banks.

Explanation:

M1 represents the narrowest measure of money supply and includes currency held by the public and demand deposits with banks (i.e., checking accounts).

Question 3. “M2” in the classification of money supply includes

  1. Currency held by the public and demand deposits with banks.
  2. Currency held by the public, demand deposits with banks, and time deposits.
  3. Currency held by the public, time deposits with banks, and savings deposits.
  4. Currency held by the public, demand deposits with banks, and time deposits, along with certain money market instruments.

Answer: 2. Currency held by the public, demand deposits with banks, and time deposits.

Explanation:

M2 includes M1 (currency held by the public and demand deposits with banks) and adds time deposits with banks (i.e., savings accounts and certificates of deposit) to it.

Question 4 “M3” in the classification of money supply includes

  1. Currency held by the public, demand deposits with banks, and time deposits.
  2. Currency held by the public, demand deposits with banks, and time deposits, along with certain money market instruments.
  3. Currency held by the public, time deposits with banks, and savings deposits, along with certain money market instruments
  4. Currency held by the public, demand deposits with banks, time deposits, and savings deposits, along with certain money market instruments.

Answer: 4.  Currency held by the public, demand deposits with banks, and time deposits, along with certain money market instruments.

Explanation:

M3 includes M2 (currency held by the public, demand deposits with banks, and time deposits) and also incorporates certain money market instruments like commercial paper and government securities.

Question 5. “Liquidity” in the context of money supply refers to

  1. The ease with which financial assets can be converted into money without loss of value.
  2. The total amount of money in circulation within an economy.
  3. The ability of banks to lend money to the government.
  4. The amount of money that individuals and firms hold in their savings accounts.

Answer: 1. The ease with which financial assets can be converted into money without loss of value.

Explanation:

Liquidity refers to the ease with which financial assets (such as stocks, bonds, or money market instruments) can be converted into cash or money without a significant loss of value. Assets that can be quickly and easily converted into cash are considered more liquid.

Question 6. How does an increase in the money supply affect inflation, according to the Quantity Theory of Money?

  1. An increase in the money supply leads to deflation.
  2. An increase in the money supply has no impact on inflation.
  3. An increase in the money supply leads to inflation.
  4. An increase in the money supply causes stagflation.

Answer: 2. An increase in the money supply leads to inflation.

Explanation:

According to the Quantity Theory of Money, an increase in the money supply, when the economy’s output and production capacity remain unchanged, will lead to an increase in the overall price level, resulting in inflation.

Question 7. What is M1 in the measurement of money supply?

  1. The narrowest measure of money supply, including only physical currency.
  2. The broadest measure of money supply, including all liquid assets and time deposits.
  3. The measure of money supply used by central banks for monetary ‘ policy.
  4. The total value of goods and services produced in an economy.

Answer: 1. The narrowest measure of money supply, including only physical currency.

Explanation:

M1 is the narrowest measure of money supply, and it includes only physical currency (coins and notes) in circulation and demand deposits (checking accounts) held by the public.

Question 8. Which of the following is considered a component of M2 in the measurement of money supply?

  1. Physical currency (coins and notes) in circulation.
  2. Demand deposits (checking accounts) held by the public.
  3. Time deposits (fixed deposits) with commercial banks.
  4. Treasury bills and government bonds.

Answer: 3. Time deposits (fixed deposits) with commercial banks.

Explanation:

M2 is a broader measure of money supply that includes all components of M1 (physical currency and demand deposits) and adds time deposits (fixed deposits) with commercial banks and other liquid assets.

Question 9. How does an increase in the money supply affect inflation, according to monetary theory?

  1. An increase in the money supply causes deflation.
  2. An increase in the money supply does not affect inflation.
  3. An increase in the money supply leads to higher inflation.
  4. An increase in the money supply reduces economic growth.

Answer: 3. An increase in the money supply leads to higher inflation.

Explanation:

According to monetary theory, an increase in the money supply tends to lead to higher inflation. When the money supply grows faster than the rate of economic growth, it can lead to an increase in demand for goods and services, which in turn can push up prices

Question 10. What role does the central bank play in controlling the money supply?

  1. The central bank has no control over the money supply.
  2. The central bank can directly control the money supply through its, policies.
  3. The central bank can indirectly influence the money supply through interest rate adjustments.
  4. The central bank can control only the currency component of the money supply.

Answer: 3. The central bank can indirectly influence the money supply through interest rate adjustments.

Explanation:

The central bank can influence the money supply through its monetary policy tools. By adjusting the interest rates (for example: the discount rate and the federal funds rate), the central bank can encourage or discourage borrowing and lending, thereby affecting the money supply in the economy.

Question 11. Which measure of money supply is the most comprehensive and includes all liquid assets?

  1. M0
  2. M1
  3. M2
  4. M3

Answer: 4. M3

Explanation:

M3 is the most comprehensive measure of money supply, and it includes all components of M2 (physical currency, demand deposits, and time deposits) and adds larger liquid assets like treasury bills, government bonds, and other financial instruments.

Question 12. Money supply refers to

  1. The total amount of money held by individuals and businesses
  2. The total value of goods and services produced in an economy
  3. The total amount of money printed by the central bank
  4. The total amount of money held in banks’ reserves

Answer: 1. The total amount of money held by individuals and businesses

Question 13. Which of the following is considered a component of the money supply in most countries?

  1. Government bonds
  2. Corporate stocks
  3. Currency (cash) in circulation
  4. Real estate

Answer:  3. Currency (cash) in circulation

Question 14. The money supply includes which of the following types of money?

  1. M1, M2, M3
  2. Physical currency only
  3. Commercial bank reserves
  4. Government bonds

Answer: 1. M1, M2, M3

Question 15. M1 money supply includes

  1. Currency (cash) in circulation, demand deposits, and traveler’s checks
  2. Currency (cash) in circulation, time deposits, and savings accounts
  3. Currency (cash) in circulation, government bonds, and corporate stocks
  4. Currency (cash) in circulation, foreign exchange reserves, and gold holdings

Answer: 1. Currency (cash) in circulation, demand deposits, and traveler’s checks

Question 16. The central bank has the most direct control over which component of the money supply.

  1. M1
  2. M2
  3. M3
  4. M4

Answer: 1. M1

Rationale Of Measuring Money Supply

Question 1. Why is it important for economists and policymakers to measure the money supply in an economy?

  1. To determine the total value of goods and services produced in the economy.
  2. To assess the overall level of economic growth and development.
  3. To understand the availability of credit and loans for businesses and individuals.
  4. To monitor the effectiveness of monetary policy and its impact on inflation and economic stability.

Answer: 4. To monitor the effectiveness of monetary policy and its impact on inflation and economic stability.

Explanation:

Measuring the money supply is crucial for economists and policymakers to monitor the effectiveness of monetary policy. Changes in the money supply can have significant impacts on inflation, economic growth, and overall economic stability. By tracking the money supply, policymakers can adjust their monetary policies to achieve their economic goals.

Question 2. Which component of the money supply is the most liquid and serves as the medium of exchange in day-to-day transactions?

  1. Physical currency (coins and notes) in circulation.
  2. Demand deposits (checking accounts) held by the public.
  3. Time deposits (fixed deposits) with commercial banks.
  4. Government bonds and securities.

Answer: 1. Physical currency (coins and notes) in circulation.

Explanation:

Physical currency in circulation, which includes coins and notes, is the most liquid component of the money supply. It is widely accepted as a medium of exchange in day-to-day transactions for goods and services.

Question 3. How does measuring the money supply help in assessing the liquidity of an economy?

  1. A higher money supply indicates higher liquidity.
  2. A lower money supply indicates higher liquidity.
  3. Measuring money supply has no relation to assessing liquidity.
  4. Liquidity is solely determined by the availability of credit facilities.

Answer: 1. A higher money supply indicates higher liquidity

Explanation:

Measuring the money supply helps assess the liquidity of an economy. A higher money supply implies that more money is available in the economy, making it easier for individuals and businesses to access funds and engage in transactions.

Question 4. What does the concept of “monetary aggregates” refer to in the measurement of money supply?

  1. The total value of all financial assets in an economy.
  2. The total value of exports and imports in an economy.
  3. The various measures of money supply are used by central banks for policy purposes.
  4. The total value of goods and services produced in an economy.

Answer: 3. The various measures of money supply used by central banks for policy purposes.

Explanation:

“Monetary aggregates” refer to the various measures of money supply used by central banks to analyze and implement monetary policy effectively. These measures include MO, M1, M2, M3, and so on, each representing a different level of liquidity in the economy.

Question 5. Why is M1 considered a narrow measure of money supply?

  1. It includes only physical currency in circulation.
  2. It includes physical currency and demand deposits but excludes time deposits.
  3. It includes physical currency and time deposits but excludes demand deposits.
  4. It includes all components of money supply, including physical currency, demand deposits, and time deposits.

Answer: 1. It includes physical currency and demand deposits but excludes time deposits.

Explanation:

M1 is considered a narrow measure of money supply because it includes only the most liquid components, such as physical currency in circulation and demand deposits held by the public, while excluding time deposits (fixed deposits).

Question 6. How does measuring the money supply assist in understanding the potential for inflation in an economy?

  1. A higher money supply indicates a lower inflation potential.
  2. A lower money supply indicates lower inflation potential.
  3. Measuring money supply has no relation to understanding inflation potential.
  4. The potential for inflation is solely determined by fiscal policy.

Answer: 2. A lower money supply indicates lower inflation potential.

Explanation:

Measuring the money supply helps in understanding the potential for inflation. A lower money supply, relative to the demand for goods and services, can indicate a lower inflation potential, as there is less money available to drive up prices.

Question 7. Why is it important to measure the money supply in an economy?

  1. To track changes in the stock market.
  2. To assess the overall health of the financial sector.
  3. To understand the level of economic activity and inflationary pressures.
  4. To determine the fiscal deficit of the government.

Answer: 3. To understand the level of economic activity and inflationary pressures.

Explanation:

Measuring the money supply is crucial for Understanding the level of economic activity and inflationary pressures in an economy the money supply can impact consumer spending, investment, and overall economic growth, as well as influence the level of inflation.

Question 8. Which of the following components is typically included in the measurement of the M1 money supply?

  1. Time deposits with commercial banks.
  2. Treasury bills and government bonds.
  3. Physical currency (coins and notes) in circulation.
  4. Foreign currency held by the central bank.

Answer: 3. Physical currency (coins and notes) in circulation.

Explanation:

M1 money supply includes physical currency (coins and notes) in circulation and demand deposits (checking accounts) held by the public. It represents the most liquid and immediate form of money.

Question 9. Which measure of money supply is more comprehensive and includes M1 plus time deposits with commercial banks?

  1. M0
  2. M1
  3. M2
  4. M3

Answer: 3. M2

Explanation:

M2 is a more comprehensive measure of money supply than M1. It includes all components of M1 (physical currency and demand deposits) and adds time deposits (fixed deposits) with commercial banks and other liquid assets.

Question 10. What is the primary objective of measuring money supply from the perspective of monetary policy?

  1. To determine the fiscal deficit of the government.
  2. To assess the overall health of the financial sector.
  3. To track changes in the stock market.
  4. To guide the formulation and implementation of monetary policy.

Answer: 4. To guide the formulation and implementation of monetary policy.

Explanation:

The primary objective of measuring money supply is to guide the formulation and implementation of monetary policy by central banks. Monetary policymakers use information about the money supply to influence interest rates, credit availability, and overall economic conditions.

Question 11. Why is the measurement of money supply considered essential for conducting monetary policy?

  1. It helps central banks predict future changes in the stock market.
  2. It provides insights into consumer spending patterns.
  3. It allows central banks to control inflation and stabilize the economy.
  4. It assists central banks in managing the fiscal deficit of the government.

Answer: 3. It allows central banks to control inflation and stabilize the economy. Explanation:

Measuring money supply is essential for conducting monetary policy as it allows central banks to monitor and control inflation and stabilize the economy. By adjusting interest rates and influencing credit availability, central banks can impact the money supply and overall economic activity.

Question 12. What does MO represent in the measurement of money supply?

  1. The narrowest measure of money supply, including only physical currency.
  2. The broadest measure of money supply, including all liquid assets and time deposits.
  3. The measure of money supply used by central banks for monetary policy.
  4. The total value of goods and services produced in an economy.

Answer: 1. The narrowest measure of money supply, including only physical currency.

Explanation:

MO is the narrowest measure of money supply, and it includes only physical currency (coins and notes) in circulation. It represents the most liquid and immediate form of money.

Question 13. The primary rationale for measuring the money supply is to

  1. Track the profitability of banks
  2. Monitor the flow of foreign exchange
  3. Assess the health of the financial system
  4. Understand the overall liquidity in the economy

Answer: 4. Understand the overall liquidity in the economy

Question 14. Which of the following monetary aggregates includes only the most liquid forms of money?

  1. M1
  2. M2
  3. M3
  4. M4

Answer: 1. M1

Question 15. The broader measures of money supply, such as M2 and M3, include

  1. Only physical currency (cash) in circulation
  2. Currency (cash) in circulation and demand deposits
  3. Currency (cash) in circulation, demand deposits, and time deposits
  4. Currency (cash) in circulation and government bonds

Answer: 3. Currency (cash) in circulation, demand deposits, and time deposits

Question 16. Measuring the money supply helps central banks in formulating and implementing

  1. Fiscal policies
  2. Monetary policies
  3. Trade policies
  4. Industrial policies

Answer: 2. Monetary policies

Question 17. The rationale for measuring the money supply is to provide an indicator of

  1. The total value of goods and services produced in an economy
  2. The level of government debt
  3. The purchasing power of money
  4. The availability of funds for spending and investment

Answer: 4. The availability of funds for spending and investment

The Sources Of Money Supply

Question 1. Which of the following is NOT considered a source of money supply in the economy?

  1. Physical currency issued by the central bank.
  2. Demand deposits held by commercial banks.
  3. Government bonds and treasury bills.
  4. Foreign currency reserves are held by the central bank.

Answer: 3. Government bonds and treasury bills.

Explanation:

Government bonds and treasury bills are not considered a source of money supply. They are financial instruments used for borrowing by the government but do not directly contribute to the money supply.

Question 2. The primary source of money supply in an economy is

  1. Physical currency held by the public.
  2. Currency issued by commercial banks.
  3. Foreign currency reserves are held by the central bank.
  4. Demand deposits held by commercial banks.

Answer: 4. Demand deposits held by commercial banks.

Explanation:

Demand deposits held by commercial banks are the primary source of money supply in an economy. These deposits can be readily used for transactions, making them an essential component of the money supply.

Question 3. Which of the following is considered a component of the monetary base, also known as MO?

  1. Demand deposits held by the public.
  2. Time deposits with commercial banks.
  3. Physical currency (coins and notes) in circulation.
  4. Government securities.

Answer: 3. Physical currency (coins and notes) in circulation

Explanation:

MO, also known as the monetary base, includes physical currency (coins and notes) in circulation and reserves held by commercial banks at the central bank.

Question 4. What role does the central bank play in controlling the money supply?

  1. The central bank has no control over the money supply.
  2. The central bank can directly control the money supply through its policies.
  3. The central bank can indirectly influence the money supply through interest rate adjustments.
  4. The central bank can control only the currency component of the money supply.

Answer: 3. The central bank can indirectly influence the money supply through interest rate adjustments.

Explanation:

The central bank can influence the money supply through its monetary, policy tools. By adjusting the interest rates (Forexample, The discount rate, and the federal funds rate), the central bank can encourage or discourage borrowing and lending, thereby affecting the money, supply in the economy.

Question 5. What happens to the money supply when commercial banks increase their lending activities?

  1. The money supply decreases.
  2. The money supply remains unchanged.
  3. The money supply increases.
  4. The money supply fluctuates randomly.

Answer: 3. The money supply increases.

Explanation:

When commercial banks increase their lending activities, they create new money in the economy through the process of credit creation. This leads to an increase in the money supply.

Question 6. Which of the following assets held by commercial banks is a component of the money supply?

  1. Government bonds.
  2. Corporate stocks.
  3. Treasury bills.
  4. Demand deposits.

Answer: 4. Demand deposits.

Explanation:

Demand deposits held by commercial banks are a component of the money supply. They represent the funds deposited by individuals and businesses that can be withdrawn on demand and used for transactions.

Question 7. Which of the following components is included in the narrowest measure of money supply (MO)?

  1. Demand deposits (checking accounts) in commercial banks.
  2. Time deposits (fixed deposits) with commercial banks.
  3. Physical currency (coins and notes) in circulation.
  4. Foreign currency reserves are held by the central bank.

Answer: 3. Physical currency (coins and notes) in circulation.

Explanation:

MO is the narrowest measure of money supply and includes physical currency (coins and notes) in circulation. It represents the most liquid form of money issued by the central bank.

Question 8. Which source of money supply represents the reserves held by commercial banks with the central bank? 

  1. Currency held by the public.
  2. Demand deposits.
  3. Bank reserves.
  4. Time deposits.

Answer: 3. Bank reserves.

Explanation:

Bank reserves represent the funds that commercial banks hold with the central bank. These reserves consist of both physical currency (vault cash) and deposits with the central bank. Bank reserves play a crucial role in determining the lending capacity of commercial banks.

Question 9. How does the central bank influence the money supply in the economy?

  1. By controlling the government’s budget deficit.
  2. By adjusting interest rates and conducting open market operations.
  3. By directly printing and issuing physical currency.
  4. By regulating foreign currency transactions.

Answer: 2. By adjusting interest rates and conducting open market operations.

Explanation:

The central bank influences the money supply through its monetary policy tools, such as adjusting interest rates (for example,  the discount rate and the federal funds rate) and conducting open market operations (buying or selling government bonds). These actions impact the reserves of commercial banks and, in turn, affect the money supply.

Question 10. Which component of the money supply represents the deposits that individuals and businesses can withdraw on demand without any notice?

  1. Time deposits (fixed deposits)
  2. Savings deposits.
  3. Demand deposits (checking accounts).
  4. Foreign currency reserves.

Answer: 3. Demand deposits (checking accounts).

Explanation:

Demand deposits, also known as checking accounts, represent deposits that individuals and businesses can withdraw on demand without any notice. They are highly liquid and form a part of the money supply.

Question 11. What is the role of the government in determining the money supply?

  1. The government directly controls the money supply by printing physical currency.
  2. The government regulates the flow of foreign currency into the country.
  3. The government sets the reserve requirements for commercial banks.
  4. The government influences the money supply through its fiscal policies and borrowing.

Answer: 3. The government sets the reserve requirements for commercial banks.

Explanation:

The government plays a role in determining the money supply by setting reserve requirements for commercial banks. Reserve requirements are the minimum amount of funds that banks must hold as reserves (cash or deposits with the central bank). Against their demand deposits. Changes in reserve requirements can impact the money supply in the economy.

Question 12. The main source of money supply in an economy is

  1. Foreign exchange reserves
  2. Government bonds
  3. Central Bank’s monetary operations
  4. Stock market investments

Answer: 3. Central Bank’s monetary operations

Question 13. Which entity has the authority to create and regulate the money supply in most countries?

  1. Commercial banks
  2. Central banks
  3. Investment banks
  4. Foreign banks

Answer: 2. Central banks

Question 14. The process by which commercial, banks create money through lending and deposit creation is known as

  1. Fractional reserve banking
  2. Currency issuance
  3. Foreign exchange trading
  4. Stock market manipulation

Answer: 1. Fractional reserve banking

Question 15. When the central bank buys government bonds from commercial banks, it leads to

  1. An increase in the money supply
  2. A decrease in the money supply
  3. No change in the money supply
  4. An increase in interest rates

Answer:  1. An increase in the money supply

Question 16. The money supply can also be affected by other non-bank financial institutions, such as

  1. Pension funds
  2. Hedge funds
  3. Insurance companies
  4. All of the above

Answer:  4. All of the above

Measurement Of Money Supply

Question 1. Which of the following measures of money supply includes physical currency (coins and notes) in circulation and demand deposits with commercial banks?

  1. M0
  2. M1
  3. M2
  4. M3

Answer: M1

Explanation:

M1 is a measure of money supply that includes physical currency (coins and notes) in circulation and demand deposits (checking accounts) with commercial banks. It represents the most liquid and immediate forms of money.

Question 2. Which component is included in M2 but not in M1 in the measurement of money supply?

  1. Physical currency (coins and notes) in circulation.
  2. Time deposits (fixed deposits) with commercial banks.
  3. Demand deposits (checking accounts) held by the public.
  4. Foreign currency reserves are held by the central bank.

Answer: 2. Time deposits (fixed deposits) with commercial banks.

Explanation:

M2 is a broader measure of money supply than M1. It includes all components of M1 (physical currency and demand deposits) and adds time deposits (fixed deposits) with commercial banks and other liquid assets.

Question 3. What does M0 represent in the measurement of money supply?

  1. The narrowest measure of money supply, including only physical currency.
  2. The broadest measure of money supply, including all liquid assets and time deposits.
  3. The measure of money supply used by central banks for monetary policy.
  4. The total value of goods and services produced in an economy.

Answer: 1. The narrowest measure of money supply, including only physical currency.

Explanation:

M0 is the narrowest measure of money supply, and it includes only physical currency (coins and notes) in circulation. It represents the most liquid and immediate form of money issued by the central bank.

Question 4. Which of the following components is typically included in the measurement of the M1 money supply?

  1. Time deposits with commercial banks.
  2. Treasury bills and government bonds.
  3. Physical currency (coins and notes) in circulation.
  4. Foreign currency reserves are held by the central bank.

Answer: 3. Physical currency (coins and notes) in circulation.

Explanation:

M1 money supply includes physical currency (coins and notes) in circulation and demand deposits (checking accounts) held by the public. It represents the most liquid and immediate form of money.

Question 5. What is the primary objective of measuring money supply from the perspective of monetary policy?

  1. To determine the fiscal deficit of the government.
  2. To assess the overall health of the financial sector.
  3. To track changes in the stock market.
  4. To guide the formulation and implementation of monetary policy.

Answer:  4. To guide the formulation and implementation of monetary policy.

Explanation:

The primary objective of measuring money supply is to guide the formulation and implementation of monetary policy by central banks. Monetary policymakers use information about the money supply to influence interest rates, credit availability, and overall economic conditions.

Question 6. How does the central bank influence the money supply in the economy?

  1. By controlling the government’s budget deficit.
  2. By adjusting interest rates and conducting open market operations.
  3. By directly printing and issuing physical currency.
  4. By regulating foreign currency transactions.

Answer: 2. By adjusting interest rates and conducting open market operations.

Explanation:

The central bank influences the money supply through its monetary policy tools, such as adjusting interest rates (For example, the discount rate and the federal funds rate) and conducting open market operations (buying or selling government bonds). These actions impact the reserves of commercial banks and, in turn, affect the money supply.

Question 7. M1 .money supply includes which of the following components?

  1. Currency (cash) in circulation and demand deposits
  2. Currency (cash) in circulation, demand deposits, and time deposits
  3. Currency (cash) in circulation, demand deposits, time deposits, and savings deposits
  4. Currency (cash) in circulation, demand deposits, time deposits, and foreign exchange reserves

Answer: 1. Currency (cash) in circulation and demand deposits

Question 8. The M2 money supply is a broader measure and includes which of the following components?

  1. Currency (cash) in circulation and demand deposits
  2. Currency (cash) in circulation, demand deposits, and time deposits
  3. Currency (cash) in circulation, demand deposits, time deposits, and savings deposits
  4. Currency (cash) in circulation, demand deposits, time deposits, and foreign exchange reserves

Answer: 3. Currency (cash) in circulation, demand deposits, time deposits, and savings deposits

Question 9. The M3 money supply is an even broader measure and includes which of the following components?

  1. Currency (cash) in circulation and demand deposits
  2. Currency (cash) in circulation, demand deposits, and time deposits
  3. Currency (cash) in circulation, demand deposits, time deposits, and savings deposits
  4. Currency (cash) in circulation, demand deposits, time deposits, and foreign exchange reserves

Answer: 4. Currency (cash) in circulation, demand deposits, time deposits, and foreign exchange reserves

Question 10. Which of the following is not included in any of the measures of money supply (M1, M2, M3)?

  1. Currency (cash) in circulation
  2. Demand deposits.
  3. Time deposits (certificates of deposit)
  4. Government bonds

Answer: 4. Government bonds

Question 11. The monetary aggregates M1, M2, and M3 are classified based on the:

  1. Periods for which the money is held
  2. Size of the economy
  3. Level of government debt
  4. Liquidity of the components included

Answer: 4. Liquidity of the components included

Determinants Of Money Supply

Question 1. Which of the following is NOT a determinant of money supply in an economy?

  1. Monetary policy decisions of the central bank.
  2. Reserve requirements set by the central bank.
  3. Fiscal policy decisions of the government.
  4. Open market operations conducted by commercial banks.

Answer: 4. Open market operations conducted by commercial banks.

Explanation:

Open market operations are conducted by the central bank, not commercial banks. They involve the buying and selling of government securities to influence the money supply. The other options are determinants of money supply: monetary policy decisions, reserve requirements, and fiscal policy decisions.

Question 2. When the central bank reduces the reserve requirements for commercial banks, it will likely lead to

  1. An increase in the money supply.
  2. A decrease in the money supply.
  3. No change in the money supply.
  4. An increase in the interest rates.

Answer: 1. An increase in the money supply.

Explanation:

When the central bank reduces the reserve requirements for commercial banks, banks are required to hold a lower percentage of their deposits as reserves. This frees up more funds for lending, leading to an increase in the money supply.

Question 3. The main tool used by the central bank to directly control the money supply is

  1. Setting interest rates.
  2. Conducting open market operations.
  3. Adjusting reserve requirements.
  4. Printing physical currency.

Answer: 3. Adjusting reserve requirements.

Explanation:

The main tool used by the central bank to directly control the money supply is adjusting reserve requirements for commercial banks. By changing the percentage of deposits that banks must hold as reserves, ’ the central bank can influence the amount of money banks can lend.

Question 4. Which of the following is an example of an expansionary monetary policy that increases the money supply?

  1. Raising the reserve requirements for commercial banks.
  2. Selling government securities in the open market.
  3. Lowering interest rates.
  4. Decreasing government spending.

Answer: 3. Lowering interest rates.

Explanation:

Lowering interest rates is an example of an expansionary monetary policy. When interest rates are reduced, borrowing becomes cheaper, leading to increased borrowing and spending by individuals and businesses, which, in turn, increases the money supply.

Question 5. The government’s budget deficit can indirectly impact the money supply through its effect on

  1. The level of economic growth.
  2. The exchange rate of the national currency.
  3. Inflation rate.
  4. Central bank’s open market operations.

Answer: 4. Central bank’s open market operations.

Explanation:

The government’s budget deficit can indirectly impact the money supply through its effect on the central bank’s open market operations. A budget deficit may lead the central bank to conduct more open market purchases (buying government securities), which increases the money supply.

Question6. In a fractional reserve banking system, the money supply is affected by:

  1. The total amount of physical currency in circulation.
  2. The proportion of deposits held as reserves by commercial banks.
  3. The rate of inflation.
  4. The government’s fiscal policy.

Answer: 2. The proportion of deposits held as reserves by commercial banks.

Explanation:

In a fractional reserve banking system, the money supply is affected by ’ the proportion of deposits that commercial banks are required to hold as reserves. By changing reserve requirements, the central bank can influence the money supply

Question 7. Which of the following is NOT a determinant of money supply in an economy?

  1. The monetary policy is set by the central bank.
  2. The level of government spending and fiscal policy.
  3. The demand for money by the public.
  4. The rate of inflation in the economy.

Answer: 4. The rate of inflation in the economy.

Explanation:

The rate of inflation in the economy is not a determinant of money supply. Instead, it is influenced by changes in money supply and other factors in the economy. The determinants of money supply include monetary policy, government spending and fiscal policy, and the demand for money by the public.

Question 8. The primary determinant of money supply in an economy is: 

  1. The demand for money by the public.
  2. The level of government spending.
  3. The monetary policy is conducted by the central bank.
  4. The rate of economic growth.

Answer: 3. The monetary policy conducted by the central bank.

Explanation:

The primary determinant of money supply in an economy is the f monetary policy conducted by the central bank. The central bank has the authority to control the money supply through various policy instruments like open market operations, reserve requirements, and discount rates.

Question 9. When the central bank increases the reserve requirement for commercial banks, it will likely result in

  1. An increase in money supply.
  2. A decrease in money supply.
  3. No change in the money supply.
  4. A decrease in interest rates.

Answer: 2. A decrease in money supply.

Explanation:

When the central bank increases the reserve requirements for commercial banks, it means banks need to hold more reserves against their deposits. This reduces the amount of money available for lending and, thus, decreases the money supply in the economy.

Question 10. How does the central bank use open market operations to affect money supply?

  1. By printing and issuing new currency.
  2. By buying or selling government securities in the open market.
  3. By controlling the government’s budget deficit.
  4. By setting interest rates for commercial banks.

Answer: 2. By buying or selling government securities in the open market.

Explanation:

The central bank uses open market operations to affect money supply by buying or selling government securities (bonds) in the open market. When the central bank buys government securities, it injects money into the economy, increasing the money supply. Conversely, when it sells government securities, it absorbs money from the economy, decreasing the money supply.

Question 11. The demand for money in an economy is influenced by

  1. The monetary policy is set by the central bank.
  2. The rate of inflation and price level.
  3. The level of government spending.
  4. The fiscal policy is conducted by the government.

Answer: 2. The rate of inflation and price level.

Explanation:

The demand for money in an economy is influenced by factors such as the rate of inflation and the price level. When prices rise, individuals and businesses may need to hold more money for transactions, leading to an increase in money demand.

Question 12. How does an increase in economic activity affect the demand for money?

  1. It decreases the demand for money.
  2. It increases the demand for money.
  3. It does not affect the demand for money.
  4. It leads to a decrease in the money supply.

Answer: 2. It increases the demand for money.

Explanation:

An increase in economic activity generally leads to an increase in the demand for money. As economic activity grows, more transactions take place, requiring individuals and firms to hold more money for their day-to-day activities.

Question 13. The primary determinant of the money supply in an economy is the

  1. Central Bank’s monetary policy
  2. Government’s fiscal policy
  3. Exchange rate fluctuations
  4. Foreign direct investment

Answer: 1.  Central Bank’s monetary policy

Question 14. When the central bank buys government bonds in the open market, it leads to

  1. An increase in the money supply
  2. A decrease in the money supply ‘
  3. No change in the money supply
  4. An increase in foreign exchange reserves

Answer: 1.  An increase in the money supply

Question 15. The reserve requirement set by the central bank for commercial banks is a determinant of money supply because it affects the banks

  1. Lending capacity and money creation
  2. Profitability and interest rates
  3. Foreign exchange holdings
  4. Investment in government securities

Answer: 1. Lending capacity and money creation

Question 16. The interest rate set by the central bank influences the money supply by affecting

  1. The level of government debt
  2. Consumer spending patterns
  3. Borrowing and lending behavior in the economy
  4. Stock market prices

Answer: 3.  Borrowing and lending behavior in the economy

Question 17. In the context of money supply, the term “monetary base” refers to

  1. The total amount of money held by individuals and businesses
  2. The central bank’s reserves and currency in circulation
  3. The total value of goods and services produced in an economy
  4. The overall value of stocks and bonds in the financial markets

Answer: 2. The central bank’s reserves and currency in circulation

The Concept Of Money Multiplier

Question 1. The money multiplier is defined as

  1. The rate at which the central bank prints new currency notes.
  2. The ratio of the money supply to the reserve requirements set by the central bank.
  3. The ratio of the change in money supply to the change in interest rates.
  4. The rate at which commercial banks create new money through through lending lending.

Answer: 4. The rate at which commercial banks create new money through lending.

Explanation:

The money multiplier is the rate at which commercial banks create new money through the process of lending. When banks receive deposits they are required to keep a portion of those deposits as reserves, and the remaining amount is available for lending. This leads to the creation of new money in the economy.

Question 2. How is the money multiplier calculated?

  1. Money Multiplier = Change in Money Supply / Change in Interest Rates.
  2. Money Multiplier = Reserve Ratio / Money Supply. ,
  3. Money Multiplier = 1 / Reserve Ratio.
  4. Money Multiplier = Change in Money Supply / Change in Reserve Ratio.

Answer: 3. Money Multiplier = 1 / Reserve Ratio.

Explanation:

The money multiplier is calculated as the reciprocal of the reserve ratio. The reserve ratio is the percentage of deposits that banks are required to hold as reserves, and the money multiplier determines how much money can be created from the initial deposit.

Question 3. What happens to the money multiplier if the reserve requirements set by the central bank increase?

  1. The money multiplier increases.
  2. The money multiplier decreases.
  3. The money multiplier remains unchanged.
  4. The money multiplier becomes zero.

Answer: 2. The money multiplier decreases.

Explanation:

If the reserve requirements are set by the center! bank increase, banks will be required to hold a larger portion of their deposits as reserves, leaving less money available for
lending. As a result, the money multiplier decreases, and the potential money creation through lending reduces.

Question 4. If the reserve ratio is 10%, what is the money multiplier?

  1. 1.10
  2. 10
  3. 0.10
  4. 0.90

Answer: 2. 10

Explanation:

The money multiplier is the reciprocal of the reserve ratio. If the reserve ratio is 10%, the money multiplier is \(\frac{1}{0.10}\) = 10. This means that for every $1 of new reserves injected into the banking system, the potential money supply can increase by $10.

Question 5. The money multiplier process can lead to

  1. An increase in the money supply and economic growth.
  2. A decrease in the money supply and economic contraction.
  3. Inflation and higher interest rates.
  4. A decrease in the reserve ratio.

Answer:  1. An increase in the money supply and economic growth.

Explanation:

The money multiplier process can lead to an increase in the money supply because banks create new money through lending. This can support economic growth as more money becomes available for investment, consumption, and other economic activities.

Question 6. What is the relationship between the reserve ratio and the money multiplier?

  1. They have a direct relationship.
  2. They have an inverse relationship.
  3. They are unrelated and independent concepts.
  4. The reserve ratio is a component of the money multiplier.

Answer: 2. They have an inverse relationship.

Explanation:

The reserve ratio and the money multiplier have an inverse relationship. As the reserve ratio increases, the money multiplier decreases, and vice versa. This is because a higher reserve ratio means banks can lend less of their deposits, leading to less money creation.

Question 7. The concept of the money multiplier is based on the idea that

  1. The central bank can directly control the money supply.
  2. Commercial banks can create money through lending activities.
  3. The government can print and issue new currency as needed.
  4. The demand for money is influenced by changes in interest rates.

Answer: 2. The commercial banks can create money through lending activities.

Explanation:

The concept of the money multiplier is based on the idea that commercial banks can create money through the process of lending. When a bank receives a deposit, it keeps a fraction of the deposit as reserves and loans out the rest.

The loaned amount becomes a new deposit in another bank, which, in turn, can lend out a portion of it, and the process continues, leading to the creation of new money in the economy. ,

Question 8. The money multiplier formula is defined as

  1. Change in money supply = Change in reserves x Reserve Ratio.
  2. Change in reserves = Change in money supply x Reserve Ratio.
  3. Change in money supply = Change in interest rates x Reserve Ratio.
  4. Change in reserves = Change in interest rates x Reserve Ratio.

Answer: 3. Change in money supply = Change in reserves x Reserve Ratio.

Explanation:

The money multiplier formula shows the relationship between the change in money supply (M) and the change in reserves (R) held by the commercial banks, and the reserve ratio (RR).

It can be expressed as follows

Change in money supply = Change in reserves x Reserve Ratio.

Question 9. The reserve ratio is defined as

  1. The total amount of money held by the central bank.
  2. The total amount of money held by the government.
  3. The ratio of commercial bank reserves to total deposits.
  4. The ratio of currency in circulation to total money supply

Answer: 3. The ratio of commercial bank reserves to total deposits.

Explanation:

The reserve ratio is the percentage of total deposits that commercial banks are required to hold as reserves with the central bank. It is a key factor in determining the potential
money creation through the banking system.

Question 10. If the reserve ratio is 10%, and the central bank injects $1,000 of new reserves into the banking system, the potential maximum increase in the money supply will be

  1. $100
  2. $1,000
  3. $10,000
  4. $100,000

Answer: $10,000

Explanation:

If the reserve ratio is 10%, the potential maximum increase in the money supply can be calculated using the money multiplier formula:

Change in money supply = Change in reserves / Reserve Ratio Change in money supply = $1,000 / 0.10 Change in money supply = $10,000

Question 11. The money multiplier process can lead to

  1. An increase in the money supply.
  2. A decrease in the money supply.
  3. No change in the money supply.
  4. An increase in interest rates.

Answer: 1. An increase in the money supply.

Explanation:

The money multiplier process allows commercial banks to create new money by making loans and expanding credit. As banks lend out a portion of their reserves, the money supply increases, leading to a multiplier effect.

Question 12. What happens to the money multiplier and potential money supply expansion if the reserve ratio increases?

  1. The money multiplier decreases, and potential money supply expansion decreases.
  2. The money multiplier increases, and potential money supply expansion increases.
  3. The money multiplier decreases, and potential money supply expansion increases.
  4. The money multiplier increases, and potential money supply expansion decreases.

Answer: 1. The money multiplier decreases, and potential money supply expansion decreases.

Explanation:

If the reserve ratio increases, commercial banks are required to hold a larger portion of their deposits as reserves, reducing their ability to lend and create new money. As a result, the money multiplier decreases, and the potential money supply expansion decreases.

Question 13. The money multiplier is a concept that represents

  1. The ratio of government spending to tax revenue
  2. The ratio of the money supply to the central bank’s reserves
  3. The ratio of government debt to GDP
  4. The ratio of the fiscal deficit to GDP

Answer: 2. The ratio of the money supply to the central bank’s reserves

Question 14. The money multiplier indicates how much the money supply

  1. Increases when the central bank buys government bonds
  2. Decreases when the central bank sells government bonds
  3. Changes in response to changes in government expenditure
  4. Responds to fluctuations in interest rates

Answer: 1. Increases when the central bank buys government bonds

Question 15. The money multiplier is influenced by the

  1. Interest rate set by the central bank
  2. Level of government debt
  3. Size of the fiscal deficit
  4. Central bank’s reserve requirement for commercial banks

Answer: 4. Central bank’s reserve requirement for commercial banks

Question 16. If the reserve requirement is 10%, the money multiplier would be: 

  1. 0.1
  2. 110
  3. 1
  4. 100

Answer: 3. 10

Question 17. The money multiplier process works based on the idea of

  1. Fractional reserve banking
  2. Government bond purchases
  3. Foreign exchange interventions
  4. Currency printing

Answer: 1. Fractional reserve banking

The Money Multiplier Approach To Supply Of Money

Question 1. The Money Multiplier Approach to the supply of money focuses on

  1. The direct control of the money supply by the central bank.
  2. The ability of commercial banks to create money through lending activities.
  3. The impact of government spending on the money supply.
  4. The relationship between money supply and interest rates.

Answer: 2.  The ability of commercial banks to create money through lending activities.

Explanation:

The Money Multiplier Approach to the supply of money emphasizes the role of commercial banks in creating money through the lending process. When banks receive deposits, they keep a fraction of these deposits as reserves and lend out the rest, leading to the creation of new money in the economy.

Question 2. The key determinant of the potential money supply expansion through the Money Multiplier Approach is

  1. The level of government spending.
  2. The interest rates are set by the central bank.
  3. The reserve ratio is set by the central bank.
  4. The exchange rate of the domestic currency.

Answer: 3. The reserve ratio set by the central bank.

Explanation:

The reserve ratio, set by the central bank, is the key determinant of the potential money supply expansion through the Money Multiplier Approach. It represents the percentage of deposits that commercial ‘ banks are required to hold as reserves with the central bank. A lower reserve ratio leads to a higher money multiplier and a larger potential money supply expansion.

Question 3. If the reserve ratio is 20%, what is the maximum potential money supply expansion if the central bank injects $1,000 of new reserves into the banking system?

  1. $1,000
  2. $2,000
  3. $5,000
  4. $10,000

Answer: $2,000

Explanation:

If the reserve ratio is 20%, the potential maximum money supply expansion can be calculated using the money multiplier formula: Potential money supply expansion = Change in reserves Reserve ratio Potential money supply expansion = $1,000 / 0.20 Potential money supply expansion = $2,000

Question 4. If the central bank wishes to reduce the money supply, it can

  1. Decrease the reserve ratio.
  2. Increase the reserve ratio.
  3. Decrease the discount rate.
  4. Increase the discount rate

Answer: 2. Increase the reserve ratio.

Explanation:

To reduce the money supply, the central bank can increase the reserve ratio. A higher reserve ratio means that banks have to hold a larger percentage of their deposits as reserves, reducing their ability to create new money through lending.

Question 5. The Money Multiplier Approach assumes that

  1. The central bank directly controls the money supply.
  2. Commercial banks do not lend out their excess reserves.
  3. The velocity of money is constant.
  4. The demand for money is determined by the interest rate.

Answer: 3. The velocity of money is constant.

Explanation:

The Money Multiplier Approach assumes that the velocity of money (the number of times money changes hands within a given period) is constant. This constant velocity is used as a simplifying assumption in the money multiplier calculation.

Question 6. The Money Multiplier Approach to the supply of money is most applicable in a situation where

  1. The central bank has strict control over the money supply.
  2. Commercial banks have limited lending activities.
  3. The economy is experiencing high inflation.
  4. There are no significant changes in the demand for money.

Answer: 4. There are no significant changes in the demand for money.

Explanation:

The Money Multiplier Approach is most applicable in a situation where there are no significant changes in the demand for money. It assumes that the demand for money is relatively stable, allowing for a more straightforward calculation of the potential money supply expansion.

Question 7. In the context of the Money Multiplier Approach, the reserve ratio refers to

  1. The ratio of currency to total money supply.
  2. The ratio of commercial bank reserves to total deposits.
  3. The ratio of government spending to GDP.
  4. The ratio of public debt to GDP.

Answer: 2. The ratio of commercial bank reserves to total deposits.

Explanation:

In the Money Multiplier Approach, the reserve ratio refers to the ratio of commercial bank reserves (required reserves and excess reserves) to total deposits. It determines the
proportion of deposits that banks are required to keep as reserves.

Question 8. The formula for calculating the money multiplier in India is

  1. Money Multiplier = Reserve Ratio / Currency Deposit Ratio.
  2. Money Multiplier = 1 / Reserve Ratio.
  3. Money Multiplier = 1 + Reserve Ratio.
  4. Money Multiplier = 1 – Reserve Ratio.

Answer: 2. Money Multiplier = 1 / Reserve Ratio.

Explanation:

The formula for calculating the money multiplier in India is given by Money Multiplier = 1 / Reserve Ratio. The money multiplier represents the multiple by which the money supply can expand through the banking system’s lending and credit creation process.

Question 9. If the reserve ratio in India is 0.1 (10%), what is the money multiplier?

  1. 0.1
  2. 1
  3. 10
  4. 100

Answer: 3. 10

Explanation:

If the reserve ratio in India is 0.1 (10%), the money multiplier can be calculated using the formula: Money Multiplier = 1 / Reserve Ratio = 1 / 0.1 = 10.

Question 10. Suppose the Central Bank of India reduces the reserve ratio from 0.12 to 0. 08. How will this impact the money supply?

  1. The money supply will increase.
  2. The money supply will decrease.
  3. The money supply will remain unchanged.
  4. The money supply will fluctuate.

Answer: 1. The money supply will increase.

Explanation:

When the central bank reduces the reserve ratio, it means banks are required to hold fewer reserves against their deposits. As a result, banks can lend out more money, leading to an increase in the money supply through the money multiplier process.

Question 11. Which of the following factors could limit the effectiveness of the money multiplier approach in determining the money supply in India?

  1. The level of government spending and fiscal policy.
  2. The demand for money by the public.
  3. The central bank’s control over the money supply.
  4. The availability of excess reserves in the banking system.

Answer: 4. The availability of excess reserves in the banking system.

Explanation:

The effectiveness of the money multiplier approach in determining the money supply can be limited by the availability of excess reserves in the banking system. If banks are already holding a significant amount of excess reserves, they may be less inclined to lend and create additional money even if the reserve ratio is reduced.

Question 12. The primary objective of the central bank in India is to:

  1. Control the money supply and inflation.
  2. Regulate the stock market and financial institutions.
  3. Control government spending and fiscal policy. 1
  4. Promote international trade and investment.

Answer: 1. Control the money supply and inflation.

Explanation:

The primary objective of the central bank in India, which is the Reserve Bank of India (RBI), is to control the money supply in the economy and ensure price stability by managing inflation.

Question 13. The Central Bank of India uses monetary policy to

  1. Control government spending and fiscal policy.
  2. Regulate the stock market and financial institutions.
  3. Control the money supply and inflation.
  4. Set interest rates for foreign investors.

Answer: 3. Control the money supply and inflation.

Explanation:

The Central Bank of India, RBI, uses monetary policy to control the money supply and manage inflation in the economy. It employs various tools like open market operations, reserve requirements, and the repo rate to achieve its monetary policy objectives.

Question 14. The primary function of commercial banks in India is to

  1. Control the money supply and inflation.
  2. Facilitate international trade and investment.
  3. Accept deposits from the public and provide loans and advances.
  4. Regulate the stock market and financial institutions.

Answer: 3. Accept deposits from the public and provide loans and advances.

Explanation:

The primary function of commercial banks in India is to accept deposits from the public and provide loans and advances to individuals, businesses, and the government.

Question 15. When a commercial bank receives a deposit from a customer, it is recorded as a liability on the bank’s balance sheet because

  1. The bank is obligated to pay interest on the deposit.
  2. The deposit represents a claim on the bank’s assets.
  3. The bank can use the deposit to make profitable investments.
  4. The deposit increases the bank’s capital reserves.

Answer: 2. The deposit represents a claim on the bank’s assets.

Explanation:

When a commercial bank receives a. deposit from a customer, it is recorded as a liability on the bank’s balance sheet because the deposit represents a claim on the bank’s assets. The bank is obligated to repay the deposit to the customer upon request.

Question 16. The process by which commercial banks create new money by making loans is known as

  1. Fractional reserve banking.
  2. Open market operations.
  3. Monetary policy.
  4. Money multiplier effect.

Answer: 1. Fractional reserve banking.

Explanation:

The process by which commercial banks create new money by making loans is known as fractional reserve banking. Banks are required to hold only a fraction of their deposits as reserves and can lend out the rest, leading to the creation of new money in the economy.

Question 17. How do commercial banks earn a profit?

  1. By charging interest on loans and paying interest on deposits.
  2. By buying and selling government securities in the open market.
  3. By investing in foreign exchange markets
  4. By borrowing from the central bank

Answer: 1. By charging interest on loans and paying interest on deposits.

Explanation:

Commercial banks earn a profit by charging a higher interest rate on the loans they provide to borrowers than the interest they pay on deposits made by customers.

Question 18. The Reserve Bank of India (RBI) regulates commercial banks in India through various measures, including

  1. Controlling the government’s fiscal policy.
  2. Setting interest rates for commercial bank loans.
  3. Regulating foreign exchange rates.
  4. Imposing reserve requirements on banks.

Answer: 4. Imposing reserve requirements on banks.

Explanation:

The Reserve Bank of India (RBI) regulates commercial banks in India by imposing reserve requirements. Banks are required to maintain a certain percentage of their deposits as reserves with the RBI, limiting their ability to
create new money.

Question 19. What happens if a commercial bank’s reserves fall below the required reserve ratio set by the central bank?

  1. The bank can continue to operate normally without any restrictions.
  2. The central bank will lend additional reserves to the bank.
  3. The bank may face penalties and restrictions on lending.
  4. The central bank will lower the reserve ratio for that bank.

Answer: 3. The bank may face penalties and restrictions on lending.

Explanation:

If a commercial bank’s reserves fall below the required reserve ratio set by the central bank, the bank may face penalties and restrictions on lending. The central bank closely monitors banks’ reserve levels to ensure
compliance with regulatory requirements.

Question 20. The public’s demand for money is influenced by: 

  1. The monetary policy is set by the central bank.
  2. The level of government spending and fiscal policy.
  3. The availability of credit facilities from commercial banks.
  4. The rate of inflation and interest rates in the economy.

Answer: 4. The rate of inflation and interest rates in the economy.

Explanation:

The public’s demand for money is influenced by factors such as the rate of inflation and interest rates in the economy. Higher inflation may lead to an increased demand for money as individuals and businesses try to hold more cash to protect against rising prices. Similarly, higher interest rates may reduce the demand for money as it becomes more expensive to borrow and hold cash.

Question 21. When the central bank increases interest rates, it is likely to impact the behavior of the public by

  1. Encouraging more borrowing and spending.
  2. Encouraging more saving and reducing spending.
  3. Encouraging more investment in the stock market.
  4. Encouraging more investment in real estate.

Answer: 2. Encouraging more saving and reducing spending.

Explanation:

When the central bank increases interest rates, it is likely to impact the behavior of the public by encouraging more savings and reducing spending.  Higher interest rates make saving more attractive as it provides higher returns on savings deposits, and it also makes borrowing more expensive, leading to reduced spending on credit-sensitive items like housing and automobiles.

Question 22. The public’s behavior regarding money and spending can significantly affect the effectiveness of monetary policy set by the central bank. This is known as

  1. Fiscal policy effectiveness.
  2. The money multiplier effect.
  3. The liquidity trap.
  4. Monetary policy transmission mechanism.

Answer: 4. Monetary policy transmission mechanism.

Explanation:

The public’s behavior regarding money and spending can significantly affect the effectiveness of monetary policy set by the central bank. This phenomenon is known as the monetary policy transmission mechanism.

The transmission mechanism determines how changes in monetary policy instruments (e.g., interest rates, money supply) affect the broader economy through changes in spending, investment, and other economic activities.

Question 23. When the public holds a higher proportion of their wealth in the form of money (cash and deposits), it is referred to as

  1. Liquidity preference.
  2. Fiscal responsibility.
  3. Risk aversion.
  4. Asset allocation.

Answer: 1. Liquidity preference.

Explanation:

When the public holds a higher proportion of their wealth in the form of money (cash and deposits) instead of other assets like stocks or bonds, it is referred to as liquidity
preference. Liquidity preference reflects the public’s preference for holding liquid assets that can be quickly converted into cash if needed.

Question 24. If the public becomes more confident about the economy’s prospects, it is likely to result in:

  1. An increase in the demand for money.
  2. A decrease in the demand for money.
  3. An increase in spending and investment.
  4. A decrease in savings.

Answer: 3. An increase in spending and investment.

Explanation:

If the public becomes more confident about the economy’s prospects, it is likely to increase spending and investment. Increased confidence can lead to higher consumer spending and business investment as individuals and businesses expect improved economic conditions in the future.

Question 25. The money multiplier approach explains how changes in the central bank’s reserves can lead to changes in the

  1. Money supply
  2. Government debt
  3. Foreign exchange reserves
  4. Interest rates

Answer: 1. Money supply

Question 26. According to the money multiplier approach, an increase in the central bank’s reserves will result in a in the money supply.

  1. Decrease
  2. Stagnation
  3. No change
  4. Increase

Answer: 4. Increase

Question 27. The money multiplier is calculated as the reciprocal of the following

  1. Reserve ratio
  2. Inflation rate
  3. Interest rate
  4. Fiscal deficit

Answer: 1. Reserve ratio

Question 28. If the reserve ratio is 10%, the money multiplier would be

  1. 1
  2. 10
  3. 0.1
  4. 100

Answer: 2. 10

Question 29. The money multiplier approach assumes that commercial banks will use their excess reserves to

  1. Decrease interest rates
  2. Increase government spending
  3. Make speculative investments
  4. Create new loans and deposits

Answer: 4. Create new loans and deposits

Question 30. Assume the reserve requirement ratio set by the central bank is 10%. If the central bank injects $1,000 of new reserves into the banking system, what will be the total increase in the money supply based on the money multiplier approach?

  1. $1,000
  2. $2,000
  3. $5,000
  4. $10,000

Answer:  2.  $2,000

Explanation:

Assume the reserve requirement ratio set by the central bank is 10%. If the central bank injects $1,000 of new reserves into the banking system, what will be the total increase in the money supply based on the money multiplier approach?

Monetary Policy And Money Supply

Question 1. Monetary policy in India is primarily formulated and implemented by

  1. The Ministry of Finance.
  2. The Securities and Exchange Board of India (SEBI).
  3. The Reserve Bank of India (RBI)
  4. The Planning Commission of India.

Answer: 3. The Reserve Bank of India (RBI).

Explanation:

Monetary policy in India is primarily formulated and implemented by the Reserve Bank of India (RBI). The RBI is the central banking institution responsible for regulating the money supply, interest rates, and credit conditions in the economy.

Question 2. The main objective of monetary policy in India is to

  1. Control government spending and fiscal policy.
  2. Regulate the stock market and financial institutions.
  3. Control the money supply and inflation.
  4. Promote international trade and investment.

Answer: 1. Control the money supply and inflation.

Explanation:

The main objective of monetary policy in India, as set by the Reserve Bank of India (RBI), is to control the money supply and ensure price stability by managing inflation in the economy.

Question 3. Open market operations (OMOs) are conducted by the Reserve Bank of India (RBI) to

  1. Control the foreign exchange rates.
  2. Regulate government spending.
  3. Control the money supply.
  4. Facilitate international trade.

Answer: 1. Control the money supply.

Explanation:

Open market operations (OMOs) are conducted by the Reserve Bank of India (RBI) to control the money supply in the economy. Through OMOs, the RBI buys or sells government securities in the open market, which has an impact on the level of reserves in the banking system and, consequently, the money supply.

Question 4. The Cash Reserve Ratio (CRR) is the percentage of deposits that banks are required to keep as reserves with the RBI. If the RBI increases the CRR, it is likely to

  1. Increase the money supply in the economy.
  2. Decrease the money supply in the economy.
  3. Has no impact on the money supply.
  4. Increase interest rates in the economy.

Answer: 2. Decrease the money supply in the economy.

Explanation:

If the RBI increases the Cash Reserve Ratio (CRR), banks are required to keep a higher percentage of their deposits as reserves with the RBI. This reduces the amount of money
available for lending and, consequently, decreases the money supply in the economy.

Question 5. The Repo Rate is the rate at which the RBI lends money to commercial banks for short periods. If the RBI decreases the Repo Rate, it is likely to

  1. Increase borrowing and spending in the economy.
  2. Decrease borrowing and spending in the economy.
  3. Have no impact on borrowing and spending.
  4. Increase the Cash Reserve Ratio (CRR).

Answer: 1. Increase borrowing and spending in the economy

Explanation:

If the RBI decreases the Repo Rate, it becomes cheaper for commercial banks to borrow money from the central bank. This, in turn, leads to lower interest rates in the economy,
making borrowing more attractive for businesses and individuals, which can increase borrowing and spending in the economy.

Question 6. Monetary policy is a tool used by the Central Bank of India to

  1. Control the government’s fiscal policy.
  2. Regulate foreign trade and exchange rates.
  3. Control the money supply and influence economic activity.
  4. Determine the budget deficit and surplus.

Answer: 1. Control the money supply and influence economic activity.

Explanation:

Monetary policy is a tool used by the central bank of India, which is the Reserve Bank of India (RBI), to control the money supply in the economy.

By influencing the money supply, the RBI aims to regulate economic activity, manage inflation, and promote economic growth.

Question 7. The Reserve Bank of India (RBI) uses various instruments to implement monetary policy. One such instrument is the “Repo Rate.” What does the Repo Rate represent?

  1. The rate at which commercial banks borrow from the RBI.
  2. The rate at which the RBI borrows from commercial banks.
  3. The rate at which the RBI lends to the government.
  4. The rate at which the RBI lends to foreign banks.

Answer: 1. The rate at which commercial banks borrow from the RBI.

Explanation:

The Repo Rate represents the rate at which commercial banks can borrow funds from the Reserve Bank of India (RBI) against the collateral of government securities. Changes in the Repo Rate can influence the cost of borrowing for commercial banks, which, in turn, affects lending rates and the money supply in the economy.

Question 8. When the Reserve Bank of India (RBI) wants to increase the money supply and stimulate economic growth, it is likely to

  1. Raise the Repo Rate.
  2. Lower the Reverse Repo Rate.
  3. Raise the Cash Reserve Ratio (CRR).
  4. Conduct open market sales of government securities.

Answer: 2. Lower the Reverse Repo Rate.

Explanation:

When the RBI wants to increase the money supply and stimulate economic growth, it is likely to lower the Reverse Repo Rate. The Reverse Repo Rate is the rate at which the  RBI borrows from commercial banks, and by reducing this rate, the RBI encourages banks to lend more and invest in higher-yielding assets, leading to increased money supply.

Question 9. Which of the following tools is used by the Reserve Bank of India (RBI) to directly control the money supply in the economy?

  1. Cash Reserve Ratio (CRR)
  2. Repo Rate
  3. Statutory Liquidity Ratio (SLR)
  4. Open Market Operations (OMOs)

Answer: 1. Cash Reserve Ratio (CRR)

Explanation:

The Cash Reserve Ratio (CRR) is the percentage of total deposits that commercial banks are required to keep as reserves with the Reserve Bank of India (RBI). By changing the CRR, the RBI can directly control the amount of money that banks can lend and influence the money supply in the economy.

Question 10. How does a decrease in the Statutory Liquidity Ratio (SLR) affect the money supply in the economy?

  1. It increases the money supply.
  2. It decreases the money supply.
  3. It does not affect the money supply.
  4. It depends on changes in the Repo Rate.

Answer: 1. It increases the money supply.

Explanation:

The Statutory Liquidity Ratio (SLR) is the percentage of total deposits that commercial banks are required to maintain in the form of liquid assets, such as government securities. When the SLR is decreased, banks are required to hold fewer reserves, allowing them to lend out more money and increase the money supply in the economy.

Question 11. Monetary policy refers to the actions taken by the central bank to

  1. Control government spending
  2. Regulate foreign exchange rates
  3. Manage the money supply and interest rates
  4. Implement fiscal measures

Answer: 3. Manage the money supply and interest rates

Question 12. When the central bank wants to increase the money supply, it can

  1. Sell government bonds in the open market
  2. Raise the reserve requirement ratio for banks
  3. Decrease the discount rate
  4. Absorb excess reserves from banks

Answer: 3. Decrease the discount rate

Question 13. If the central bank reduces the reserve requirement ratio for commercial banks, it will likely result in

  1. An increase in the money supply
  2. A decrease in the money supply
  3. No change in the money supply
  4. A change in the exchange rate

Answer: 1. An increase in the money supply

Question 14. Open market operations involve the central bank buying or selling government bonds. When the central bank buys government bonds from the market, it

  1. Increases the money supply
  2. Decreases the money supply
  3. Does not affect the money supply
  4. Increases government debt

Answer: 1. Increases the money supply

Question 15. Contractionary monetary policy is characterized by the central bank’s actions to

  1. Increase government spending
  2. Lower taxes.
  3. Reduce the money supply and raise interest rates
  4. Increase the money supply and lower interest rates

Answer: 3. Reduce the money supply and raise interest rates

Effect Of Government Expenditure On Money Supply

Question 1. When the government of India increases its expenditure and pays for it by borrowing from the banking system, what is the likely impact on the money supply?

  1. The money supply will increase.
  2. The money supply will decrease.
  3. The money supply will remain unchanged.
  4. The money supply will fluctuate.

Answer: 1. The money supply will increase.

Explanation:

When the government of India increases its expenditure and finances it by borrowing from the banking system, it injects additional funds into the economy. This increases the money supply as banks lend to the government, creating new money in the process.

Question 2. In India, which of the following tools does the Reserve Bank of India (RBI) use to offset the impact of government expenditure on money supply?

  1. Open market operations.
  2. Changes in the Statutory Liquidity Ratio (SLR).
  3. Changes in the Repo Rate.
  4. Changes in the Cash Reserve Ratio (CRR).

Answer: 1. Open market operations.

Explanation:

To offset the impact of government expenditure on money supply, the Reserve Bank of India (RBI) can use open market operations. Through open market operations, the RBI buys or sells government securities in

Question 3. When the Indian government increases its expenditure on infrastructure projects and welfare programs, the likely impact on the money supply in the economy will be

  1. An increase in the money supply.
  2. A decrease in the money supply.
  3. No impact on the money supply.
  4. A fluctuation in the money supply.

Answer:  1. An increase in the money supply.

Explanation:

When the Indian government increases its expenditure on infrastructure projects and welfare programs, it injects money into the economy.

This increased government spending leads to higher incomes for businesses and individuals, which in turn increases their ability to spend and invest. As a result, the money supply in the economy expands.

Question 4. The impact of government expenditure on the money supply depends on

  1. The level of taxation in the economy.
  2. The extent of borrowing by the government from the central bank.
  3. The government’s fiscal deficit
  4. All of the above.

Answer: 4. All of the above.

Explanation:

The impact of government expenditure on the money supply depends on various factors, including the level of taxation in the economy (as higher taxes can reduce disposable income and spending), the extent of borrowing by the government from the central bank (which affects the money creation process), and the government’s fiscal deficit (as deficit financing can influence money supply growth)

Question 5. When the government finances its expenditure through borrowing from the central bank, it is likely to lead to

  1. An increase in the money supply.
  2. A decrease in the money supply.
  3. No change in the money supply
  4. An increase in the government’s fiscal deficit.

Answer: 1. An increase in the money supply.

Explanation:

When the government finances its expenditure through borrowing from the central bank, it increases the money supply in the economy. This is because the central bank creates new money to provide funds to the government, which in turn leads to an expansion of the money supply.

Question 6. If the Indian government reduces its expenditure and runs a budget surplus, the impact on the money supply will likely be

  1. An increase in the money supply.
  2. A decrease in the money supply.
  3. No change in the money supply.
  4. An increase in government borrowing.

Answer: 1. A decrease in the money supply.

Explanation:

If the Indian government reduces its expenditure and runs a budget surplus, it means the government is collecting more in taxes than it is spending. This withdrawal of funds from the economy reduces the money supply, leading to a decrease in overall money circulation.

Question 7. The interaction between government expenditure and the money supply is an essential consideration for:

  1. Monetary policy implementation by the central bank.
  2. Fiscal policy implementation by the government.
  3. Exchange rate management by the Reserve Bank of India.
  4. Regulation of foreign trade and tariffs.

Answer: 2. Fiscal policy implementation by the government.

Explanation:

The interaction between government expenditure and the money supply is an essential consideration for fiscal policy implementation by the government. Government spending and borrowing decisions directly impact the money supply in the economy, which in turn influences economic growth, inflation, and overall economic stability.

Question 8. When the government increases its expenditure by borrowing from the central bank, what will be the impact on the money supply?

  1. Increase in the money supply
  2. Decrease in the money supply
  3. No change in the money supply
  4. The impact depends on the type of government expenditure

Answer: 1. Increase in the money supply

Question 9. Government expenditure that is financed through tax revenue has what effect on the money supply?

  1. Increase in the money supply
  2. Decrease in the money supply
  3. No change in the money supply
  4. The impact depends on the level of taxation

Answer: 3. No change in the money supply

Question 10. The effect of government expenditure on the money supply is influenced by the government’s financing method. When the government borrows from the public to finance its spending, it can lead to

  1. An increase in the money supply
  2. A decrease in the money supply
  3. Inflation
  4. A reduction in public debt

Answer:  1. An increase in the money supply

Question 11. Expansionary fiscal policy, which involves increasing government expenditure, can lead to an increase in the money supply if the government

  1. Prints additional currency notes
  2. Borrows from commercial banks
  3. Increases taxes to finance the expenditure
  4. Sells government bonds in the open market

Answer: 2. Borrows from commercial banks

Question 12. The impact of government expenditure on the money supply can be limited if the central bank conducts offsetting monetary policy actions, such as

  1. Increasing the reserve requirement ratio for banks
  2. Decreasing the interest rates
  3. Selling government bonds in the open market
  4. Implementing exchange rate interventions

Answer: 3. Selling government bonds in the open market

Question 13. Assume the reserve requirement ratio set by the central bank is 10%, and the initial money supply (M1) is $1,000. If the government spends an additional $200 on goods and services and the money multiplier is 5, what will be the total change in the money supply?

  1. $200
  2. $500
  3. $1,00
  4. $1,200

Answer: 2. $500

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