UPSC Civil Services 2020 Prelims General Studies Paper I

Explanation-

1.Monetary policy is the process by which a central bank (Reserve Bank of India or RBI) manages money supply in the economy. The objectives of monetary policy include ensuring inflation targeting and price stability, full employment and stable economic growth.

3. The money supply can be directly affected through reserve ratios or open market operations and can be indirectly affected by using key interest rates to influence the cost of credit.

4. Expansionary monetary policy works by expanding the money supply faster than usual or lowering short-term interest rates. It is enacted by central banks and comes about through open market operations, reserve requirements (reducing SLR), and setting interest rates (Lowering Bank Rate, Repo Rate for less costly lending). Hence Statement 1 and 3 are incorrect.

An increase in the MSF rate leads to higher borrowing cost for the banks and thus, reduces money supply in the economy. Hence Statement 2 is correct.

5. A contractionary or tight monetary policy reduces liquidity and increases interest rates which has a negative impact on both production and consumption and therefore, economic growth.