Ans 1.

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Creation of money: Starts with the printing process, then it changes forms. Commercial
banks accept deposits from the people and lend money to others performing as a financial
intermediary helping in expansion. Banks, however, keep with themselves, some amount
reserved. The concept of reserve ratio comes into play: Minimum Requirement + Excess
Reserves. This fractional reserve system mandates some amount to be reserved with
themselves or with the central bank, while rest (excess) is free for lending out. The former is
essential to handle usual cash inflows/outflows.
For instance, say the reserve ratio requirement is 30%. When a Rs.100 bill gets deposited in
a bank, it will have to set aside Rs.30 and can only lend Rs.70. The amount lent out is the
money created. When this Rs.70 is deposited in yet another bank, Rs.21 will be set aside
while Rs.49 will again be lent out, leading to new money, Rs.49 to be created. This process
keeps going on, in an economy. In fact, when the central bank of a country wants to
increase the money supply in the economy, they simply lower the reserve ratio (r).
Thus, Initial deposit = Rs.100
r=0.3
Total amount created = 100 * 1/0.3 = Rs.333.33
New money created = Total - Initial = Rs. 233.33
This happened in the very first step. Now consider this going on indefinitely: 100 + (100*0.7
+ 100*(0.7)^2 + 100*(0.7)^3 …so on)
= 100(1/1-0.7) = 100(1/0.3) = 100(1/r)
The above expression shows how there's a multiplier effect on the money.

Digital revolution is more of a boon for the central bank (RBI) in regulating money supply
because of the following reasons:
1. Firstly, the more banking moves towards digital, the faster lending gets and thus
increasing the speed of money creation- shorter turnaround time.
2. Digital payments leave a footprint for each transaction made, leading to more robust
monitoring.
3. Today, customers want to spend money in smaller amounts but with greater
frequency. Digital advancements like India's UPI has really helped that cause. This
also comes with the advantage of easy record keeping.
4. With the emergence of electronic money has had a significant impact on the
demand for banknotes issued by the RBI. This has led to a decline in its revenues
too, as issuing electronic money can be handled by institutions other than the RBI.
5. RBI's pursuit of guiding, like it has been doing may become futile with an increasing
trend of banks to issue electronic money, while various online payment platforms
are often difficult to control. That's because internet does not have a typical
physical presence and is not subject to political/social boundaries. All this may result
in easing the grip of the RBI in the credit guide.

Ans 2.)
Inflation is described as continuous increase in the price levels of an economy. In
macroeconomics, inflation is caused due to 2 reasons:
 1. Demand Pull inflation: It means that when the spending in the economy is in excess
of the capacity to produce the output. Some economists believe that inflation is a
demand side phenomenon where increase in income of people leads to increase in
aggregate demand. Another way of increasing demand is increase in the money
supply. Hence, according to quantity theory of money, MV=PT, rise in level of prices
is caused by increase in money supply. Thus, this theory shows that increase in
money supply has a direct impact on inflation.
2. Cost-Push Inflation: A few economists also believe that inflation is caused when
there is supply side effects in the cost of production. When the cost of production
rises, it results in cost push inflation i.e., economy’s supply of goods and services
decline leading to rise in price levels and AS curve shifts to the left.
In an actual economy, the situation is much more complex. Distinguishing between the 2
theories is difficult. Hence, in an economy as large as India, considering that inflation is only
due to monetary phenomena is not true. In India, certain industries face rising demand and
some face falling demand. The industries where demand is high, the prices and wages rise,
but the industries where demand is not high, there the wages and prices are sticky and
inflexible to decline. Hence, the overall prices rise. Thus, both cost push and demand pull
word simultaneously. Hence, it is said that in India, inflation is structural in nature where
structural changes have impact on unemployment and inflation.
Along with this, expectations of the workers also come into play. India has strong
unionisation, hence if the expected inflation by workers is high, they demand a higher pay
leading to higher actual inflation. Policies such as APMC and infrastructural bottlenecks also
cause inflation.
Thus, we can say that inflation in India is a multi-fold in nature. Money supply (Monetary
policies) have an impact, but they are not the sole reason for it.

Ans 3.)
The only way to respond to unprecedented financial crises is to adopt means that are
unconventional, that have never been adopted before, and that is the path that central
banks across the world choose to go down, that is their primary response when such a
situation arises. Looking at the pandemic in context of the 2008 financial crisis, it will only be
an understatement to say that it is an exponentially bigger challenge for economies across
the globe.
This is why and in what situations unconventional monetary policies should be implemented
– The money market’s inflation and liquidity are maintained at desired levels by the central
banks by adjusting the interest rates. They generally do not lend to the government or the
private sector institutions, neither do they purchase any debt instruments.
But when the times get tough and the nominal interest rates come down to a zero, the
bank reserves cannot be lowered any further because that would put the banks at the risk
of defaulting. This is when central banks come ahead to fight recession and deflation. Now,
open market operations come into play. They exercise quantitative easing by buying non-
government securities.
When the nominal interest needs to be brought down to zero levels and it’s not possible to
cut rates beyond that, unconventional methods pump money into the economy through
monetary stimulus.
If the monetary policy transfer process is faulty even when the interest rates are above zero,
unconventional means need to be adopted.
Central’s banks across the world have taken up such measures multiple times, a few
examples could be –
• Riksbank, Sweden’s Central Bank brought in negative interest rates upto -0.25% in
July 2009 and in 2014 European Central Bank lowered its deposits rate to -0.10%.
• The Fed bought non-government bonds in the open market to bring in money into
the economy after the fall of Lehman Brothers Holdings Inc. and introduced QE.

Ans 4.)
Expenditure multiplier is defined as change in the aggregate income of the economy when
in response to the change in aggregate expenditure.
Y=Multiplier x Autonomous Expenditure
Multiplier= 1/1-MPE
=1/MPS
Fiscal deficit is the total borrowing requirement by the government.
Fiscal deficit = (Revenue receipts + recovery of loans + non-debt capital receipts) minus Total
Expenditure.
Hence, financing the fiscal deficit is done in several ways. The 4 ways are defined as follows:
1. Borrowing from domestic market: Government issues bonds and other instruments
in the open market. The savings of the individuals are diverted towards the purchase
of these bonds. There is no effect in the money supply in the economy. The money
demand increase causing a rise in interest rate. This crowds out the private
expenditure of individuals and causes an effect on the multiplier. Interest rates rise
and private expenditures fall.
2. Increase in Taxes: Increase in taxes reduce the willingness of individuals to work and
prioritize leisure more. It also reduces the disposable income of the individuals. This
reduces the proportion of individuals on consumption and hence cause and impact
on the expenditure multiplier and reduces it. Therefore, a rise in government
spending due to increase in tax will not increase overall AD as an increase in G
(government spending) is offset by a fall in C.
 3. Borrowing from central bank of the country: In this method, government finances
through borrowings from RBI. This method increases the money supply in the
economy. Hence, there is increase in spending by the individuals. This has a positive
impact on the multiplier and this “Multiplier effect” is in place.
4. Borrowing from abroad: Government meets the expenditure through borrowing
from abroad. In this method, the domestic money supply or demand is not affected.
Hence, there is no effect on the multiplier.

Ans 5.)
Labour force participation rate is labour force as a % of total population (Above 16 years)
Whereas unemployment rate is total number of able-bodied people who are willing to work
but cannot fine jobs at the existing wage rate divided by total labour force.
In India, the women labour participation rate is very low. It is 71% for men but only 11% for
women. Moreover, their unemployment rate is also very high. Women face a higher
unemployment rate as compared to men. There is also a surprising factor that rural women
have a higher participation rate as compared to urban even though they are less educated.
Post lockdown, there has been a focus on increasing the consumption that is impacting the
demand side of the economy. But it is now important to even revise policies for the supply
of labour side of the economy.
Thus, I believe that it is imperative that the policy makers focus on both the rates but with
respect to women, the participation rate seems more important. This is needed because it is
important for the government to understand why even after proper education, there is lack
of participation amongst the women. This is disrupting the economy and the GNP. A lot of
resources are employed in providing education and skill to women who have attained higher
education. These resources become sunk cost if not employed into productivity. India is a
developing country, increase in skilled labour force will add tremendously to the economy.
The root cause for lower women participation is the quality of labour and dumping along
with outsourcing. Thus, policy makers can focus on helping the economy and its stakeholders
create quality jobs and employ domestically rather than informalizing it. The government
needs to alter the labour code of the economy and promote more of formal labour.
Providing skill is a part of working towards reducing unemployment. Policymakers should
simultaneously focus on frictional unemployment as well so that it does not change into
structural if people are not skilled up enough. Policies like Beti padhao and skill up will further
augment into the betterment of the same.
Thus, there is a dire need to focus on both the rates but it is imperative to focus on the labour
participation rate in order to reduce the sunk cost and the opportunity cost being created in
the economy.
Thus, government can focus on labour participation rate so as to:
1. Fix supply side shocks and short run productivity
2. if not addressed will lead to structural challenges of lower productivity and output
which will slow down the economy
3. It would increase the already widened gap of income between make and female and
will also effect the inclusivity index of the economy.

Ans 6.)
Philips curve shows the relationship between inflation and unemployment. According to it,
there is an inverse relationship between unemployment rate and rate of inflation.
The Phillips curve states that inflation depends on
• expected inflation
• cyclical unemployment: the deviation of the actual rate of
unemployment from the natural rate
• supply shocks

Short Run
It is assumed that there is a demand-pull inflation. The graph when plotted, it is a negatively
sloped line as shown below. It shows a trade-off between the unemployment rate and
inflation rate. The Short run effects for a rise in AD on the price level and real output when
AS if given: high rates of inflation will be accompanied by low rates of unemployment. Any
policy (Fiscal and monetary) that would boost AD will simultaneously reduce unemployment
but also increase inflation.

Long Run: But in the long run, this does not hold true. The Philips curve is a vertical line parallel
to Y axis. There is no trade off between inflation and unemployment. At the natural rate of
unemployment, any rate of inflation is consistent. Expected rate of inflation equals the actual
rate. It can be seen through the diagram below

Whenever there is rise in unemployment, the government injects resources in the economy.
This results in a short-term fall in unemployment and a higher inflation. The higher inflation
further revises the expectations for an even higher inflation and thus the process continues.
The short run fall in unemployment is temporary as AS shifts and unemployment will start to
rise again. Thus, in the longer run the economy operates at the natural level of
unemployment.

Hence, it is seen that in the short run there exists an inverse relationship but in the longer run
there is no trade off.

Ans 7.)
China has historically relied heavily upon exports. It was a major exporter of many goods as
the labour cost in the country was very low. But since the pandemic has hit, the country has
lost its strength. There is loss of confidence and rivalry of China with countries like India and
US where is mainly exported. Due to all this, China’s reliance on exports have fallen. US- China
ties have not been very good in the past times. Many companies are also shifting their base
from China to Vietnam Cambodia India etc.
Hence, “Dual Circulation” policy is being used by China in which China would cater to its
domestic market as well as move towards self-reliance for many sectors.
In dual circulation, there isn’t complete close off to the external ties rather a balance between
self reliance and external circulation. It is achieved through fostering domestic consumption.
China is focusing on increasing the purchasing power of its citizens so that AD is bolstered.
China is also focusing on becoming technologically independent by fostering production of
semiconductors etc that were mainly outsourced. Through this, it aims to lessen the income
gaps and reduce inequality.
This self-sufficiency will help China become more domestically powerful. This is not a step
towards anti-globalisation but surely china will face rivalry from US. Reducing Tariffs will make
it easier for China to increase its purchasing power. It will simultaneously bolster its ties with
other foreign countries and improve its image.

Ans 8.)
The various exchange rate regimes are:

1. Fixed Exchange Rates: In such a regime, the country's currency value is pegged/fixed by a
monetary authority (usually a central bank) against the value of another currency (typically
the US Dollar), a basket of other currencies(usually a mix of the US Dollar, Euros, Yen etc.),
or another measure of value (like gold). If the value of its currency changes too much,
the monetary authority intervenes.
This intervention is done by buying and selling its own currency to keep the exchange rate at
the value of its liking. If the overall balance lowers (negative), the forex price increases
leading to depreciation of its currency. In this scenario, the monetary authority sells some of
its Forex reserves to maintain the exchange rate at a certain value. If the overall balance is
surplus, the reverse is done, by accumulating more of the forex reserves.

2. Flexible Exchange Rates: The exchange rates under this regime are purely determined by
the global demand and supply of currency. There is absolutely no intervention from the
monetary authority, neither the government nor the central bank. The adjustments are
hence made through changes in the exchange rate rather than changes in the money
supply. This regime gained popularity when the gold standards failed. While the monetary
policy under this regime can be independent with no overpricing or underpricing, the
problems get posed when the exchange rates are very volatile and change frequently. In
that case, the monetary policy doesn't remain independent anymore.

3. Managed float- heterogeneous approach: Managed float as the name suggests lets the
exchange rate in most cases to be floating. However, the monetary authority, in some cases
intervenes by buying/selling of forex reserves. India has been following this regime since
1994. The exchange rates are allowed to be determined by the open market but with some
influence of forex reserves' manipulation.