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Vision IAS Mains 2020 Test 4 Answers
Vision IAS Mains 2020 Test 4 Answers
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APPROACH - ANSWER: GENERAL STUDIES MAINS MOCK TEST - 1394 (2020)
2. Explain why Micro, Small and Medium Enterprises (MSME) sector is regarded as the ‘growth
engine’ of the Indian economy. Suggest key reforms that are required for improving the overall
business climate for MSMEs in India.
Approach:
Highlight the reasons as to why MSME sector is considered as the growth engine of Indian
economy.
Briefly mention the issues facing this sector.
Suggest reform measures for improving the overall business climate for MSME sector in India.
Answer:
With a vast network of about 63.38 million enterprises, MSME sector contributes to about 45% of
manufacturing output, more than 40% of exports and over 28% of GDP. Besides, MSMEs create
employment for about 111 million people. The sector produces a wide range of products, from
simple consumer goods to high-precision, sophisticated finished products. It has also been
contributing significantly to the expansion of entrepreneurial base through business innovations.
Due to its tremendous multiplier impact on economic growth, and its forward and backward
linkages with industry, it is rightly considered the growth engine of Indian economy.
However, MSMEs in India face a lot of constraints such as high cost of credit; low access to new
technology and marketing; poor access to international markets; lack of skilled manpower;
inadequate infrastructure and regulatory issues related to taxation, labour laws and environment.
In this regard, the following key reforms, as discussed in the UK Sinha Committee report, are
needed to improve the business climate for MSMEs:
Addressing the cumbersome registration process and promote use of Unique Enterprise
Identifier (UEI) like PAN for purposes like procurement, availing government sponsored
benefits, etc.
Establishing Enterprise Development Centers (EDCs) in each district for capacity building of
entrepreneurs.
MSME clusters should collaborate with companies having innovation infrastructure, R&D
institutions and universities.
Considering their vulnerability and size, insolvency code / delegated legislation should provide
for out-of-court assistance such as mediation, debt counseling etc. to MSMEs.
Creation of a Digital Public Infrastructure to reduce loan-operating costs significantly and also
address information asymmetry that improves credit access.
Creation of a National Council for MSMEs to facilitate coherent policy outlook and uniform
monitoring.
The MSMED Act, 2006 should be amended and its focus should be towards market facilitation
and ease of doing business.
It must be ensured that MSMEs come to terms with the ongoing structural changes in the economy
(like GST) and fully benefit from advances in digitization. This shall also substantially reduce the
cost and time for this sector and enhance its ease of doing business.
3. The average size of holdings has shown a steady declining trend over the last three decades.
What are the challenges faced by farmers due to fragmentation of land? What needs to be done
in this regard?
Approach:
Introduce briefly declining trend of land holding size as well as current scenario in this regards.
Mention the challenges faced by farmers due to fragmentation of land.
4. Distinguishing between a flexible and fixed exchange rate system, explain how exchange rate is
determined under a flexible exchange rate system.
Approach:
Introduce by defining exchange rate.
Highlight the difference between flexible and fixed exchange rate system.
Explain how exchange rate is determined in a flexible exchange rate system.
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Answer:
The price of one currency in terms of the other currencies is known as the exchange rate. There are
generally two types of regimes that determine exchange rates – fixed exchange rate system and
flexible exchange rate system.
The differences between the two are as follows:
A Fixed exchange rate is an exchange rate of the currency that is fixed at some level with
respect to some benchmarks like US dollar or gold and adjusted only infrequently. Whereas,
Flexible/floating exchange rate is an exchange rate which is determined by the forces of
demand and supply in the foreign exchange market.
A fixed rate is set by the government or Central Bank and is also maintained at that level. But,
in flexible system, the central banks do nothing to directly affect the level of the exchange
rate.
Fixed exchange rate regime is less susceptible to volatility and fluctuations and generally
depends on change in government policy, whereas currencies under flexible exchange rate
regime are susceptible to volatility and high fluctuations as it depends on day to day scenario
and market conditions.
Change in exchange rate in fixed regime is termed as devaluation or revaluation whereas in
flexible regime it is termed as depreciation or appreciation.
Determination of exchange rate under a flexible exchange rate system:
Let us understand how exchange rate is determined in a flexible exchange rate system, by taking a
two country model of say, India and USA:
Under a Flexible Exchange Rate system, the
equilibrium rate of exchange is determined by
forces of demand and supply of foreign exchange.
The demand of foreign currency arises to
import goods & services; to purchase financial
assets abroad; send gifts/grants etc. It varies
inversely with the exchange rate. This because,
at a high exchange rate, the amount of rupees
required per unit dollar would be high and vice
versa. The demand curve plotted against
exchange rate is therefore downward sloping.
Similarly, the supply of foreign currency arises
because of export of domestic goods; arrival of
foreign tourists; foreigners undertaking direct
investment; remittances etc. The supply of foreign currency varies directly with the exchange
rate. This is because a higher exchange rate gets more rupees per unit currency. This increases
the profitability of the exporters. The supply curve plotted against exchange rate is therefore
forward sloping.
The flexible exchange rate system autocorrects any disequilibrium in the balance of
payments. This means that any deficit or surplus in the BoP automatically triggers movement
in the exchange rate to an equilibrium value where the demand and supply of foreign exchange
becomes equal again.
For instance, if a deficit occurs in an economy i.e. increase in imports, there will be excess
demand of foreign currency. Such a demand will lead to the appreciation of the foreign
currency & depreciation of the domestic currency. Imports will become expensive and
exports more profitable. The quantity demanded of the foreign exchange will fall and quantity
supplied rise till the deficit is eliminated. This will be the new higher equilibrium value of the
exchange rate. Similarly, a surplus in the balance of payments leads to an appreciation of the
domestic currency. Hence, exports will fall while imports increase till the surplus is eliminated
at the new lower equilibrium value of the exchange rate.
5. Discuss why enacting appropriate land leasing laws should be given priority in India.
Approach:
Introduce by giving a brief background on the objectives of land reform in India.
Mention the fallouts in terms of meeting these objectives.
Discuss the benefits of an appropriate land leasing framework.
On the basis of aforementioned points, make a brief conclusion.
Answer:
Land reforms in India had aimed to eliminate all forms of exploitation and social injustice
within the agrarian system; to provide security for the tiller and remove impediments to
agricultural production. However, the land reforms have only been partially successful in achieving
these objectives.
One of the major weak links has been restrictive land leasing laws that forced tenancy to be
informal, insecure and inefficient. With the rising levels of income, the prices of agricultural lands
are going up and, therefore, landless agri-labourers and small/marginal farmers cannot buy land.
This has adversely impacted the growth of agriculture in India.
There is a need for appropriate land leasing laws which would help in the following ways:
Security of tenure to tenant: It would incentivize tenant cultivators to invest in and conserve
agricultural land resources, which in turn, leads to increased land productivity and profitability.
Benefits of different schemes to the tenants: Legal documents can facilitate access to
institutional credit. Besides, it makes it possible to extend the benefits of various schemes such
as DBT for fertilizer subsidy, crop insurance, disaster relief etc. to the real cultivators.
Security to the land-owner: Legal backing provides a greater sense of security to the owner. It
will also help contain the problem of fallow land due to fear of losing ownership rights.
Dispute Resolution: A legal framework would provide owners as well as tenants with a safe
legal route for conflict resolution.
Land consolidation: It will open doors for the consolidation of the operational land holdings
which is essential to exploit scale economies and increase farm incomes.
Attract private investment in agriculture: Long-term leasing can facilitate contract farming
and lead to crop diversification; introduction new farming techniques and technologies;
investment in post-harvest management and processing etc.
Therefore, appropriate land leasing laws are much needed for agricultural efficiency, equity and
occupational diversification. In this context, a model land leasing law has also been proposed by
NITI Aayog.
6. Gross Domestic Product (GDP) of a country can not be taken as an index of the welfare of the
people of that country. Analyse.
Approach:
Explain the concept of GDP.
Discuss the view that GDP is not an index of welfare in a country.
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Conclude briefly by using examples of some other indicators used to depict the level of social
well-being in a country.
Answer:
Gross Domestic Product (GDP) is the total monetary or market value of all finished goods and
services produced within a country's borders in a specific time period. As a broad measure of
overall domestic production, it functions as a comprehensive scorecard of the country’s economic
health.
It is a good indicator to depict the living conditions of people in a country, as it includes a number of
factors such as consumption and investment. However, it can not be taken as an index of the welfare
of the people of a country. The reasons include:
It doesn’t measure equity in income distribution: If the GDP of a country is rising, its social
indicators may not rise as a consequence. This is because rise in GDP may be concentrated in
the hands of a few individuals or firms. For the rest, the income may, in fact, have fallen.
Non-monetary exchanges: Many activities in an economy are not evaluated in monetary
terms. For example, the domestic services that women perform at home are not paid for. Since
there is no transaction of money, their contribution is generally not counted in the GDP, leading
to underestimation of GDP.
Externalities: Externalities refer to the benefits (or harms) a firm or an individual causes to
another for which they are not paid (or penalised). For instance, while calculating GDP,
pollution caused by industries is not accounted for. Therefore, if we take GDP as a measure of
welfare of the economy, we will overestimate the actual welfare. In cases of positive
externalities, GDP will underestimate the actual welfare of the economy.
Type of goods produced: GDP does not describe the kinds of goods that are being produced.
Since GDP measures the value of all finished goods and services within an economy, it also
includes products that may have negative effects on social welfare. For example, tobacco,
armaments etc. sold and used within the country, would adversely impact the overall social
welfare.
In view of the shortcomings mentioned above, there have been various attempts to develop more
accurate and reliable indicators in order to measure social well-being. Among others, these
alternative approaches include the Human Development Index (HDI), the Gross National Happiness
Index (GNH), and the Social Progress Index (SPI).
7. Bringing out the difference between depreciation and devaluation of a currency, explain how
they affect foreign trade of a country.
Approach:
Briefly discuss the meaning of depreciation and devaluation of a currency.
Highlight the key differences between depreciation and devaluation of a currency.
Bring out their effect on the foreign trade of a country.
Answer:
Both depreciation and devaluation highlight the economic condition where there is a decrease in
the value of a domestic currency in comparison to any other currency, leading to a decline in the
currency’s purchasing power. However, the manner in which they occur are different. The
differences between depreciation and devaluation are:
Depreciation happens in the floating exchange rate regime, in which the market forces
determine the value of a country's currency. On the other hand, devaluation is associated with
the fixed/pegged exchange rate regime.
Depreciation is a decrease in the value of domestic currency due to the market forces of
demand and supply. Whereas, in case of devaluation, the Central bank deliberately makes
downward adjustment of the value of the domestic currency vis-a-vis any other
currency.Depreciation can occur on a daily basis, while devaluation is usually done
occasionally by the Central bank.
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Effects of depreciation and devaluation on the foreign trade of a country are:
Reducing trade deficit: Both depreciation and devaluation make imports expensive. Hence,
residents often buy fewer imported goods. On the other hand, exported goods become less
costly for international buyers, thereby, growing demand for exports. Thus, fewer imports and
more exports will reduce the trade deficit and could also lead to surplus. However, the trade
deficit may not reduce as much as expected or even increase if imports constitute essential
commodities that are difficult to replace with domestic products.
Reduced foreign investment: Both depreciation and devaluation are viewed as a sign of
economic weakness, therefore, the creditworthiness of the nation may be jeopardized. It may
dampen investor confidence in the country's economy and hurt the country's ability to secure
foreign investment. However, if the increased aggregate demand for domestic goods, owing to
reduced imports and more external demand, leads to higher inflation and in turn higher interest
rates, then it may also attract foreign investment.
Instability in the global markets: Trading partners may become concerned that it might
negatively affect their export industries. Also, neighboring countries might devalue their own
currencies to offset the effects of their trading partner's devaluation. Such competitive
devaluations tend to exacerbate economic difficulties by creating instability in the global
financial markets.
In a free market economy, devaluation should be used sparingly. While the negative effects of
depreciation can be countered by focusing on long term measures like improving export
competitiveness, increasing efficiency of supply chains and pro-active government policies.
8. Explain the mechanism of credit creation by the banking system in an economy. What are the
factors that limit such credit creation?
Approach:
Introduce with a brief note on credit creation.
Discuss the factors important in determining credit creation.
Explain the process of credit creation in detail.
Discuss the factors limiting creation of credit by the banks.
Conclude on the basis of the above points.
Answer:
Credit creation refers to the ability of the commercial banks to multiply loans and advances by
creating deposits. Commercial banks create credit by advancing loans and purchasing securities.
The money lent to individuals and businesses comes from deposits of the public held by these
banks. The banks are required to reserve a certain portion of these deposits with it, to serve cash
requirements of depositors and lend only the remaining portion of public deposits.
Mechanism of credit creation:
Suppose a customer of Bank X deposits an amount of Rs. 1000 in this bank. Bank X keeps a cash
reserve of 20 per cent, i.e. Rs. 200 and uses the excess reserve i.e. Rs. 800 in advancing loan to one of
its customers by opening an account in his name. This borrower from Bank X uses this amount in
buying goods from some trader and makes payment by drawing a cheque on Bank X. Suppose this
trader has his account in Bank Y. It will deposit this cheque of Rs 800 in Bank Y to be collected from
Bank X.
Thus, Rs. 800 will be transferred from Bank X to Y. Bank Y also keeps 20 per cent, i.e. Rs. 160 and is
left with an excess reserve of Rs 640, which it lends to another customer. Another such transaction,
say with Bank Z, will leave it with Rs. 512. Thus an initial deposit of Rs. 1000 has resulted in the
creation of deposits by three banks amounting to Rs. (1000+800+640+512) = Rs. 2952. This is how
the entire banking system will be able to create new deposits and hence credit creation happens.
9. With the help of a diagram, explain the circular flow of income in a simple economy.
Approach:
Briefly highlight the concept of circular flow of income.
State the different phases of the flow of income, using a diagram.
Explain, in detail, the concept of circular flow of income in a simple economy using a diagram
and conclude accordingly.
Answer:
The circular flow of income is an economic model, which depicts exchanges between different
agents in an economy as flows of money, services etc. It basically demonstrates how money/factor
services moves from producers to consumers and back again in an endless loop.
Phases of circular flow of income:
Production phase: Firms produce goods and services with the help of factor services i.e. land,
labour, capital and entrepreneurship.
Income phase: It involves the flow of factor income (rent, wages, interest, profit) from firms to
households.
Expenditure phase: The income received by the factors of production is spent on goods and
services produced by firms.
However, the above illustration is a simplified model, which does not describe the actual economy
in detail. For instance, in an actual economy, households save, the government is involved, there is
international trade etc.
10. Explain the meaning of Balance of Payments and give an account of various components
included within current and capital account.
Approach:
Briefly explain Balance of Payment and mention its components.
Explain Current and Capital accounts and also, mention their various components as well.
Concluding statement may contain the overall idea of BOP.
Answer:
The Balance of Payments (BoP) is a statement of all transactions (goods, services, and assets)
made between entities in one country and the rest of the world over a defined period of time. The
Balance of Payments is maintained by the central monetary authority of a nation.
According to the IMF, there are two main accounts in the BoP i.e. the current account and the capital
& financial account. However, in India we club the financial and capital account into one and call it
the capital account. Consequently, there are two main accounts in the BoP i.e. the current account
and the capital account.
Current account: The Current Account records transactions relating to export and import of
goods, services, unilateral transfers and international incomes. Thus, the balance on current
account is the value of exports minus the value of imports, adjusted for international incomes and
transfers. The net difference between exports and imports of goods is called Balance of Trade.
When trade in services and net transfers are also factored in with the trade balance, the result is
current account balance. The balance of current account need not always be equal i.e. in
equilibrium, and can show a surplus or deficit. A surplus current account means that the nation is a
12. Explain the different quantitative and qualitative policy tools used to regulate money supply in
the economy.
Approach:
Start with a brief note on money supply and how it works.
Mention the definitions of quantitative and qualitative methods of money supply regulation in
the economy.
Enlist different quantitative and qualitative methods.
Conclude on the basis of the above points.
Answer:
The money supply is the entire stock of currency and other liquid instruments circulating in a
country's economy as of a particular time. It is regulated by the central bank using monetary policy
tools. In India, it is done by the RBI, using various quantitative and qualitative methods, to ensure
inflation targeting, price stability and stable economic growth.
Quantitative or General methods are those which are used by the central bank to influence the
total volume of credit and money supply in the banking system, without any regard for the use to
which is put while qualitative or selective measures are those which are used by the central bank
to regulate the flow of credit in specific sectors of the economy.
Quantitative methods of money regulation include:
Bank rate Policy - A deliberate manipulation of the bank rate (rate charged by the central bank
for lending funds to commercial banks) to influence the flow of credit created by the
commercial banks is known as bank rate policy. A decrease in the bank rate results in credit
becoming cheaper.
Open market operations - Open market operations (OMOs) refer to the sale and purchase of
government securities by the central bank to the commercial banks. It includes Repo and
Reverse Repo Rates. They enable mobilization of budgetary resources and act as an instrument
to siphon off the excess liquidity in the system.
Reserve Requirements: A certain amount of bank deposits is kept with the central bank. It
regulates money supply by influencing the volume of excess reserves with the commercial
banks and also the credit multiplier of the banking system. In India this is the Cash Reserve
Ratio (CRR).
Statutory Liquidity Ratio (SLR): SLR is the percentage of funds banks need to maintain in the
form of liquid assets at any point in time. When the SLR is high, banks have less money for
commercial operations and hence less money to lend out.
Deficit Financing: The central bank can print more money, but it results in more inflation and
isn’t the wisest choice to control money supply.
Quantitative Easing: The central bank infuses a pre-determined quantity of money into the
economy by buying government bonds or other financial assets from commercial banks and
private entities.
Qualitative methods include following:
Regulation of margin requirement- ‘Margin’ refers to the part of loan amount not financed by
the bank. A rise in the margin requirement results in a contraction in the borrowing value of the
security and vice-versa. Changes in margin requirements are designed to influence the flow of
credit against specific commodities.
Credit rationing- It is a method by which the central bank seeks to limit the maximum amount
of loans. It helps in lowering banks credit exposure to unwanted sectors.
Regulation of consumer credit – The central bank uses this method to restrict or liberalise the
loan conditions in order to check inflation and stabilise the economy.
Overall, the money supply and the effectiveness of credit control measures in an economy depends
upon a number of factors and these measures are essential towards maintaining the overall
financial health of an economy and stabilise its macro-economic indicators.
14. Why is the RBI called as the 'lender of last resort'? What other functions are performed by RBI
while acting as a banker to commercial banks and the government?
Approach:
Give a brief introduction about the concept of ‘lender of last resort’.
Discuss why the RBI is called as the 'lender of last resort'.
Enumerate the other functions that are performed by the RBI.
Conclude on the basis of the above points.
Answer:
A ‘lender of last resort’ is an institution, usually a country's central bank, which offers loans to banks
or other eligible institutions that are experiencing financial difficulty or are considered highly risky
or near collapse.
In India, when the commercial banks exhaust all resources to supplement their funds at times of
liquidity crisis, they approach the Reserve Bank of India (RBI) as a last resort. As a ‘lender of last
resort’, the RBI gives guarantee of solvency and provides financial accommodation to these
commercial bank by counting their eligible securities and bills of exchange and providing loans
against their securities.
Thus, 'lender of last resort' is a financial safety net provided by the RBI to the commercial banks.
The RBI extends this facility to protect the interest of the depositors of the bank and to prevent
possible failure of the bank, which in turn may also affect other banks and institutions leading to the
possible breakdown of the banking system. This can have an adverse impact on financial stability
and thus on the economy of the country.
Commercial banks usually try not to borrow from the RBI because such action indicates that the
bank is experiencing a financial crisis. Also, the unlimited extension of 'lender of last resort' will
make banks take risky decisions, expecting the RBI to come to the rescue of a risk taking and failing
bank.
In addition to the above role as a ‘lender of last resort’, the RBI performs the following functions:
1) As a banker of banks:
Under the Banking Regulation Act, 1949, the RBI has extensive powers to supervise and control
the banking system of the country.
It enables smooth and swift clearing and settlements of inter-bank transactions.
It provides efficient means of fund transfer for all banks.
It enables banks to maintain their accounts with the RBI for statutory reserve requirements and
maintenance of transaction balances.
2) As a banker to the Government:
Under the Reserve Bank of India Act, 1934, the RBI acts as a banker agent and adviser to the
government. It has an obligation to transact the banking business of the Central government and
the state governments. For example, the RBI receives and makes all payments on behalf of the
government, remits its funds, buys and sells foreign currencies for it and advices it on all
banking matters.
The RBI helps both the Central and state governments to float new loans and manage public
debt.
On behalf of the Central government, it sells treasury bills and provides short-term finance.
15. What are the key issues in fiscal management in India? How can these issues be addressed?
Approach:
Give a brief introduction about the importance of fiscal management.
Discuss the various issues regarding fiscal management in India.
Bring out measures to address the issues.
Conclude on the basis of the above points.
Answer:
Fiscal management is the process of planning, directing and controlling the financial resources. It is
important to improve investment sentiment, increase credit availability to the private sector,
control inflation and bring fiscal deficit under control.
Issues with fiscal management in India:
Inadequate budget reporting: Budgets often overstate revenue projections and understate
expenditures.
Increased reliance on Extra Budgetary Resources (EBRs): Over the years, the government’s
reliance on EBRs such as funds of state-owned enterprises like the LIC, SBI etc. to fund public
programmes has increased. However, it does not appear in real time fiscal deficit numbers.
Limited tax buoyancy: Tax buoyancy shows no stable pattern, thus, it becomes difficult to
forecast tax revenues.
Understating fiscal deficits: Fiscal deficits are understated by the use of creative accounting
techniques such as rolling over a part of the overall subsidy bill and dues to the states to the
next financial year, using PSEs like LIC to purchase divested stakes in the disinvestment process,
etc.
Absence of uniform fiscal consolidation rules for the Centre and states: Due to which states
have constraints in managing their finances.
Non-adherence to the Fiscal Responsibility and Budget Management Act (FRBMA)
targets: Since its enactment, there have been many occasions when the FRBMA targets have
been flouted. Further, there has only been post-facto assessment regarding Compliance of the
FRBMA by the CAG.
Adoption of fiscal populism measures: Like loan waivers to farmers, tax waivers to MSMEs
etc., which add a burden to the public exchequer.
These issues can be addressed through various measures as follows:
Establishing an Independent Fiscal Council to monitor fiscal policies, help attain fiscal targets
and keep a check on the fiscal consolidation of the Centre and states, as suggested by the N K
Singh Committee.
Stating correct estimates of revenue and expenditure on the budget in order to formulate
sound economic policies thereafter.
Bringing coherence between the Centre and states in terms of laws related to fiscal
management.
Enhancing cooperation between the Finance Commission and the GST Council.
Curbing populism and strictly adhering to fiscal targets by the government. Further, there
should be proper monitoring and efficient management of public expenditure.
Rationalisation of the FRBMA so that the ratio of public debt to GDP is stabilized at a
sustainable level.
Establishing an institutional mechanism for sound fiscal practices, which will bring in
transparency and instill confidence among domestic and foreign investors.
Adequate fiscal management is pertinent to stabilize the economy and attain India’s goal of
becoming a 5 trillion dollar economy by 2024.
17. Bringing out the difference between fiscal deficit, primary deficit and revenue deficit, explain
the implications of a high fiscal deficit on the economy.
Approach:
Start with a definition of deficit and differentiate between fiscal deficit, primary deficit and
revenue deficit by explaining their meanings.
Discuss the implications of a high fiscal deficit on the economy.
Conclude briefly.
18. What do you understand by fiscal policy? Explain its key objectives.
Approach:
Briefly explain the term fiscal policy and its role in economy.
Discuss the key objectives of Fiscal Policy.
Give a brief conclusion accordingly.
19. Explain, in brief, the various components of budget receipts and expenditure.
Approach:
Introduce with the definition of budget and its constitutional provisions in India.
Elaborate the different components of budget receipts as well as budget expenditure.
Write brief conclusion.
Answer:
A government budget is an annual financial statement showing item wise estimates of expected
revenue and anticipated expenditure during a fiscal year. There is a constitutional requirement in
India U/A 112 to present before the Parliament an ‘Annual Financial Statement’, which constitutes
the main budget document of the government.
Various components of a government Budget is shown below:
20. Highlight the monetary and fiscal measures that can be taken to address the phenomenon of
inflation. Also explain their limitations.
Approach:
Define Inflation.
Discuss the monetary and fiscal measures that are adopted to control inflation separately.
Briefly mention the mechanism of inflation targeting in India.