Monetary Policy & Inflation (Ch. 8–9)

A comprehensive set of flashcards covering key concepts related to Monetary Policy and Inflation as per UPSC Economics syllabus.

What happens if banks consistently fail to meet CRR requirements over multiple reporting cycles?

It leads to compounding penalties and reflects structural liquidity issues within the banking system.

How does an increase in the repo rate affect the bond market in terms of yield and pricing?

Bond yields rise and prices fall as investors demand higher returns to offset increased borrowing costs.

Why does reverse repo act as a floor for interest rates in the monetary policy corridor?

It sets the minimum return banks expect for parking funds, influencing all short-term interest rates.

How does inflation targeting conflict with expansionary monetary policies?

Tightening policy to control inflation may reduce growth, conflicting with growth-supportive expansion.

If RBI adopts a dovish stance amid rising inflation, what long-term credibility risks arise?

It erodes institutional trust and may weaken the effectiveness of future monetary policy signals.

Why is Monetary Policy considered more dynamic than Fiscal Policy?

Monetary policy adjusts frequently, using market-based tools, unlike budget-dependent fiscal policy.

What are the implications if the RBI fails to meet inflation targets for three consecutive quarters?

RBI must formally explain the failure to the government, triggering potential reviews or credibility concerns.

How does the Liquidity Adjustment Facility ensure short-term stability in banking operations?

It balances liquidity injection and absorption, maintaining interbank stability.

How does standing deposit facility differ fundamentally from reverse repo in collateral terms?

SDF requires no collateral unlike reverse repo, enhancing flexibility for liquidity absorption.

How does Moral Suasion balance authority and flexibility in qualitative control?

It uses non-statutory persuasion, aligning market actions with RBI goals without legal coercion.

Why is the impact of CRR generally broader but less sector-specific compared to SLR?

CRR impacts system-wide liquidity, while SLR can be tailored to safeguard against bank-specific risk.

What does a ‘hawkish’ monetary stance imply for credit-intensive sectors like MSMEs?

Tight credit availability increases interest costs, deterring lending to vulnerable growth sectors.

How does Operation Twist flatten the yield curve and influence corporate investments?

It narrows long-term bond yields, making long-term corporate borrowing cheaper.

How would excessive reliance on MSS affect liquidity in the bond market?

It drains liquidity rapidly, potentially raising yields and reducing bond market depth.

If RBI stops Open Market Operations completely, what liquidity management alternatives remain?

Tools like MSS, TLTRO, and LAF remain available, but precision of OMO is hard to replace.

How does MSF provide a safety net to banks during sudden liquidity crunches?

It allows access beyond regular LAF limits, protecting banks from short-term liquidity shocks.

What policy contradiction arises when both repo rate and inflation are rising?

It complicates policy communication, creating uncertainty in credit and investment decisions.

How does increasing SLR help manage systemic risks without directly reducing liquidity?

SLR reduces excessive lending by mandating safe asset holdings, lowering risk exposure.

If LAF rates are out of sync with repo rates, what confusion may arise in monetary policy signaling?

Conflicting rate signals undermine policy credibility and confuse market participants.

How does the RBI use long-term repo operations to reduce transmission lags?

It supports longer-term lending at favorable rates, easing transmission to corporate lending.

Why is TLTRO considered more effective for credit-specific stimulus than general liquidity tools?

It forces banks to channel funds into productive sectors like MSMEs and NBFCs.

How does rationing of credit reflect both qualitative and moral suasion features?

It uses both regulatory control and persuasive appeals, reflecting hybrid policy action.

If selective credit control is misused, what sectors may face unjustified credit constraints?

It may crowd out necessary investment or destabilize credit flow to productive sectors.

What happens when inflation is driven by supply shocks but RBI still uses contractionary tools?

It may fail to curb price rise and worsen output contraction, leading to policy ineffectiveness.

How does the Monetary Policy Trilemma restrict India’s ability to manage interest rates and currency?

It limits India’s ability to simultaneously manage interest rate autonomy and capital flows.

How does bond yield respond to contractionary monetary policy?

Yields rise as bond demand drops due to higher borrowing costs and reduced liquidity.

Why are base effects critical in interpreting inflation trends accurately?

It may distort actual inflation trends, making recent inflation seem exaggerated or subdued.

What does a rising headline inflation with falling core inflation suggest?

Temporary price rises are skewing headline inflation, while underlying demand is soft.

How does skewflation create problems for monetary policy decision-making?

It creates policy dilemmas, as general tools can’t target commodity-specific inflation.

What is the risk of focusing too heavily on CPI-combined when WPI and core inflation diverge?

It may lead to misjudged rate decisions that hurt industrial or rural demand sectors.

If CPI-IW inflation rises but CPI-C remains low, what wage-related policy mismatches may arise?

Wages linked to CPI-IW may rise while monetary easing occurs based on CPI-C trends.

How does a high inflation premium impact fixed-income savers and borrowers?

Borrowers gain at the expense of savers, weakening real returns and investment in bonds.

What are the dangers of sustained disinflation on investment and output levels?

It discourages credit growth and leads to idle capacity and recessionary pressures.

How does the Phillips Curve lose relevance during stagflation?

Rising inflation and unemployment break the inverse Phillips curve logic, confusing policy response.

How does the RBI use WPI data differently from CPI in macroeconomic planning?

WPI helps producers but lacks consumer relevance; RBI prioritizes CPI for demand management.

What institutional changes allowed CPI to become the anchor for inflation targeting?

The 2016 amendment to RBI Act and CPI-C’s relevance made it the inflation target metric.

Why is the CPI considered more consumer-relevant than WPI?

CPI reflects actual consumer experience and is not distorted by producer-side price shifts.

What would happen if India transitions from WPI to Producer Price Index (PPI)?

PPI may improve accuracy but lacks service sector prices and faces data standardization issues.

Why is core inflation seen as a better long-term indicator of price stability?

Core inflation filters volatile items, showing demand-driven trends more clearly.

What impact does a weak currency due to inflation have on India's import-heavy sectors?

Import costs rise, trade deficits widen, and inflation accelerates due to rupee depreciation.

How does the RBI handle inflationary pressures caused by global oil price hikes?

By adjusting repo and reverse repo rates and using forex reserves for currency stability.

What happens if inflation accounting is ignored in budget formulation?

Budgets may overstate real income or underestimate future liabilities, leading to fiscal slippage.

What trade-off does the RBI face between controlling inflation and promoting growth?

Reducing inflation may reduce demand and investment, risking growth slowdown.

Why is housing inflation important for urban monetary policy considerations?

Urban rents, housing demand, and EMI rates directly influence consumption and savings.

How does base year revision in CPI affect policy interpretation and historical comparisons?

It recalibrates inflation measurement, impacting rate-setting and benefit indexation.

What happens if food inflation is the sole contributor to headline inflation?

It limits broad inflation interpretation and can lead to narrow targeting errors.

How does asset inflation undermine monetary policy’s effectiveness?

Rising asset prices divert resources from productive sectors and widen inequality.

If inflation spiral continues unchecked, what wage-price feedback loop emerges?

Wage hikes follow price rise, fueling further inflation in a self-reinforcing loop.

Why is deflation considered worse than moderate inflation in economic terms?

It discourages spending, delays investment, and can lead to economic stagnation.

How does the inflationary gap reflect overheating of the economy?

It indicates demand far exceeds productive capacity, leading to overexpansion.