Mohamed Sathak A.

J College of Engineering Change is the true end of all learning

Fundamentals of Economics – CW3301 –Unit 5 Question Bank – (2 Marks & 16 Marks)

Part – A
1. Define Monetary Policy?
Monetary policy is a set of tools used by a nation's central bank to control the overall money
supply and promote economic growth and employ strategies such as revising interest rates and
changing bank reserve requirements.
KEY TAKEAWAYS

 Monetary policy is a set of actions to control a nation's overall money supply and achieve
economic growth.
 Monetary policy strategies include revising interest rates and changing bank reserve
requirements.
 Monetary policy is commonly classified as either expansionary or contractionary.
 The Federal Reserve commonly uses three strategies for monetary policy including
reserve requirements, the discount rate, and open market operations.

2. What are the types and goals of Monetary Policy?

Types of Monetary Policy

A. Contractionary
B. Expansionary

Goals of Monetary Policy

A. Inflation
B. Unemployment
C. Exchange Rates

3. What are the tools of Monetary Policy?

A. Repo rate

B. Cash Reserve Ratio

C. Statutory Liquidity Ratio

D. Reverse Repo Rate

E. Bank Rate

4. Define Cash Reserve Ratio.

Cash Reserve Ratio or CRR is the minimum amount as specified by the Central Bank, to be
maintained by the Commercial banks of the public deposits with the Central Bank.
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5. What is Liquidity Trap?

A liquidity trap is an adverse economic situation that can occur when consumers and investors
hoard cash rather than spending or investing it even when interest rates are low, stymying
efforts by economic policymakers to stimulate economic growth

6. Define Central Bank. What is the name of the Central Bank in India?

A central bank is a public institution that manages the currency of a country or group of
countries and controls the money supply – literally, the amount of money in circulation. The
main objective of many central banks is price stability. In some countries, central banks are
also required by law to act in support of full employment.

Reserve Bank of India is the central bank in India

7. Define Statutory Liquidity Ratio

Statutory Liquidity Ratio or SLR is the minimum percentage of deposits that a commercial
bank has to maintain in the form of liquid cash, gold or other securities. It is basically the
reserve requirement that banks are expected to keep before offering credit to customers. The
SLR is fixed by the RBI and is a form of control over the credit growth in India.

8. Define REPO Rate

Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of
India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is
used by monetary authorities to control inflation.

9. Define Reverse Repo Rate

Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in
case of India) borrows money from commercial banks within the country. It is a monetary
policy instrument which can be used to control the money supply in the country.

10. What is a Bank Rate?

The bank rate is the rate of interest which is charged by a central bank while lending loans to
a commercial bank. In the event of a fund deficiency, a bank can borrow money from the
central bank of a country. In India’s case that would be the Reserve Bank of India. The
borrowing is done as per the basis of the monetary policy of that country.

Part – B

1. How RBI governs the economy through different banking rates?

Policies of The RBI steer the economy of our country. India’s central banking institution is the
Reserve Bank of India or the RBI. Among its various functions, the RBI also controls the monetary
policy of the Indian currency.
Policies of the RBI

The RBI commenced its operations in the year 1935, on April 1st, under the Reserve Bank of India
Act. After India’s independence, the RBI was nationalized on January 1st, 1949. It also regulates the
currency and credit systems in the country. The RBI has its headquarters in Mumbai.
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Structure of the RBI

The banker of banks, the RBI is governed by a Central Board of Directors which is appointed by the
Government of India. The directors of the RBI are appointed for a term of four years. The Central
Board comprises of Official Directors and Non-Official Directors. The Official Directors are
the Governor and not more than four Deputy Governors. Apart from the above designations, there are
also four other Directors, each from four local boards. These directors of the local boards represent
the four regions of the country- Mumbai, Chennai, Kolkata and New Delhi.

The current RBI governor is Mr. Urijit Patel, who has taken over from Mr. Raghuram Rajan in the
year 2016. He is the 24th Governor of the RBI. Prior to taking up this role, he served as the Deputy
Governor for some time. Mr. Patel worked for the IMF and also went on deputation from the IMF to
the RBI, where he had an advisory role. Later, he became a Consultant to the Ministry
of Finance, Government of India. He also worked in several high-level committees, some of which
include Task Force on Direct Taxes, Prime Minister’s Task Force on Infrastructure, Group of
Ministers on Telecom Matters, Committee on Civil Aviation Reforms, Expert Group on State
Electricity Boards, High-Level Expert Group on Civil & Defense Services Pension System etc.

Monetary Policies

The Central Bank, the RBI formulates, implements and monitors the monetary policy. In fact, the
monetary policy and the fiscal policy are the two tools of macroeconomic policy. The monetary policy
mainly ensures that there is price stability coupled with economic growth. The key areas that these
policy targets are the interest rates, bank credits, and money supply.

Some of the objectives of the monetary policy include maintenance of price stability, ensuring
adequate flow of credit to the productive sectors, expansion of credit facility, equitable distribution of
credit, promotion of fixed deposits etc. The RBI also uses some tools to regulate the monetary policy.
These include

1. Open Market operations,

2. Bank Rate,

3. Cash Reserve Ratio (CRR),

4. Statutory Liquidity Ratio (SLR),

5. Repo rate,

6. Reverse Repo rate etc. There are also some Qualitative instruments that the RBI uses which impact
the money supply indirectly.

A few key terms explained

Bank Rate – It is the interest rate at which RBI gives loans to the banks.
Mohamed Sathak A.J College of Engineering Change is the true end of all learning

Cash Reserve Ratio – It refers to the minimum funds that banks have to keep with the RBI.

Statutory Liquidity Ratio- It is the fraction of the net time and demand liabilities of the banks in the
form of liquid assets that banks have to maintain.

Repo rate – It is the interest rate at which RBI gives loans to commercial banks.

Reverse Repo Rate – The interest rate at which RBI borrows from commercial banks is called the
reverse repo rate.

2. Discuss the objectives of Fiscal Policy and explain on how it is met and also elucidate its
components
Fiscal Policy deals with the revenue and expenditure policy of the Govt. The word fiscal has been
derived from the word ‘fisk’ which means public treasury or Govt funds.

Latest Update about Fiscal Policy of India:

 The Union Budget 2021 has signalled the emphasis on the Development Financial Institutions
(DFIs) in the pursuit of long-term infrastructure creation for the revival of the economy.
 The establishment of the Dispute Resolution Committee (DRC) has been proposed in
the Union Budget 2021 that can help provide quick relief to taxpayers in tax disputes.
The following are the objectives of the Fiscal Policy:

1. Higher Economic Growth

2. Price Stability
3. Reduction in Inequality
The above objectives are met in the following ways:

1. Consumption Control – This way, the ratio of savings to income is raised.

2. Raising the rate of investment.
3. Taxation, infrastructure development.
4. Imposition of progressive taxes.
5. Exemption from the taxes provided to the vulnerable classes.
6. Heavy taxation on luxury goods.
7. Discouraging unearned income.

What are the components of Fiscal Policy?

There are three components of the Fiscal Policy of India:

1. Government Receipts
2. Government Expenditure
3. Public Debt
Aspirants should note that all the receipts and expenditures of the government are credited and debited
from the following:
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1. Consolidated Fund of India

2. Contingency Fund of India
3. Public Account of India

Government Receipts

The categorisation of the government receipts is given below:

1. Revenue Receipt

 Tax Revenue

 Direct Tax

 Indirect Tax

 Non Tax Revenue

 Fees

 License and Permits

 Fines and Penalties, etc

2. Capital Receipt

 Loans Recovery

 Disinvestments

 Borrowing and other liabilities

Debt Trap – Situation where the borrower has to borrow again for the payment of an instalment on
the previous debt. A borrower unable to meet debt service obligations without borrowing is known to
be in a debt trap

Direct Tax Code Bill 2010

It hasn’t been implemented yet. The bill seeks to replace the following taxes:

1. Income Tax Act of 1961

2. Wealth Tax Act of 1957

Disinvestment

When the government sells or liquidates its assets of Central Public Sector Enterprises, State Public
Sector Enterprises or other assets; it is referring to disinvestment. This approach caters to the
objective of fiscal burden reduction.
Mohamed Sathak A.J College of Engineering Change is the true end of all learning

Government Expenditure

There are two classifications of public expenditure:

1. Revenue Expenditure – It is a recurring expenditure:

 Interest Payments

 Defence Expenses

 Salaries to Central Government employees, etc are examples of revenue

expenditure

2. Capital Expenditure – It is a non-recurring expenditure

 Loans repayments

 Loans to public enterprises, etc.

What is Fiscal Consolidation?

The measures that are taken to improve the fiscal deficit comes under the process of fiscal
consolidation. Through fiscal consolidation, the government tries for:

1. Improvement in revenue receipts

2. Better alignment in the public expenditure
The government introduced the FRBM Act aiming for fiscal consolidation. Read about it below:

Fiscal Responsibility and Budget Management Act (FRBMA), 2003

The objective of this FRBM Act is to impose fiscal discipline on the government.

It means fiscal policy should be conducted in a disciplined manner or a responsible manner i.e.
government deficits or borrowings should be kept within reasonable limits and the government should
plan its expenditure in accordance with its revenues so that the borrowing should be within limits.

Fiscal Federalism

It refers to the distribution of resource between centre and states.

The distribution of taxes between centre and states is mentioned in the 7th schedule of the Indian
constitution.

There are 3 lists where the taxes are distributed

 Union List
Mohamed Sathak A.J College of Engineering Change is the true end of all learning

 State List
 Concurrent List

3. Unemployment is a very serious economic problem. Discuss its types, Causes and remedies.

What is Unemployment?

Unemployment is a term referring to individuals who are employable and actively seeking a job but
are unable to find a job. Included in this group are those people in the workforce who are working but
do not have an appropriate job. Usually measured by the unemployment rate, which is dividing the
number of unemployed people by the total number of people in the workforce, unemployment serves
as one of the indicators of a country’s economic status.

Understanding Unemployment

The term “unemployment” is often misunderstood, it as it includes people who are waiting to return to
a job after being discharged, yet it does not include individuals who have stopped looking for work in
the past four weeks due to various reasons such as leaving work to pursue higher
education, retirement, disability, and personal issues. Also people who are not actively seeking a job
but do want to work are not classified as unemployed.

Interestingly, people who have not looked for a job in the past four weeks but have been actively
seeking one in the last 12 months are put into a category called the “marginally attached to the labor
force.” Within this category is another category called “discouraged workers,” which refers to people
who have given up looking for a job.

The categories mentioned above sometimes cause confusion and debate as to whether the
unemployment rate fully represents the actual number of people who are unemployed. For a full
understanding, one should juxtapose “unemployment” with the term “employment,” which the Bureau
of Labor Statistics (BLS) describes as individuals aged 16 and above who have recently put hours into
work in the past week, paid or otherwise, because of self-employment.

Types of Unemployment

 There are basically four types of unemployment:

(A) demand deficient,

(B) frictional,

(C) structural, and

(D) voluntary unemployment.

A. Demand deficient unemployment

 Demand deficit unemployment is the biggest cause of unemployment that typically

happens during a recession. When companies experience a reduction in the demand
for their products or services, they respond by cutting back on their production,
making it necessary to reduce their workforce within the organization. In effect,
workers are laid off.

B. Frictional unemployment
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 Frictional unemployment refers to those workers who are in between jobs. An

example is a worker who recently quit or was fired and is looking for a job in an
economy that is not experiencing a recession. It is not an unhealthy thing because it is
usually caused by workers trying to find a job that is most suitable for their skills.

C. Structural unemployment

 Structural unemployment happens when the skills set of a worker does not match the
skills demanded by the jobs available, or alternatively when workers are available but
are unable to reach the geographical location of the jobs.
 An example is a teaching job that requires relocation to China, but the worker cannot
secure a work visa due to certain visa restrictions. It can also happen when there is a
technological change in the organization, such as workflow automation that displaces
the need for human labour.

D. Voluntary unemployment

 Voluntary unemployment happens when a worker decides to leave a job because it is

no longer financially compelling. An example is a worker whose take-home pay is
less than his or her cost of living.

Causes of Unemployment

 Unemployment is caused by various reasons that come from both the demand side, or
employer, and the supply side, or the worker.
 Demand-side reductions may be caused by high interest rates, global recession, and
financial crisis. From the supply side, frictional unemployment and structural
employment play a great role.

Effects

 The impact of unemployment can be felt by both the workers and the national
economy and can cause a ripple effect.
 Unemployment causes workers to suffer financial hardship that impacts families,
relationships, and communities. When it happens, consumer spending, which is one
of an economy’s key drivers of growth, goes down, leading to a recession or even a
depression when left unaddressed.
 Unemployment results in reduced demand, consumption, and buying power, which in
turn causes lower profits for businesses and leads to budget cuts and workforce
reductions. It creates a cycle that goes on and on that is difficult to reverse without
some type of intervention.
 Long-term Unemployment vs. Short-term Unemployment
 Unemployment that lasts longer than 27 weeks even if the individual has sought
employment in the last four weeks is called long-term unemployment. Its effects are
far worse than short-term unemployment for obvious reasons, and the following are
noted as some of its effects.
 Some 56% of the long-term unemployed reported a significant decrease in their net
worth.
 Financial problems are not the only effects of long-term unemployment as 46% of
those in such a state reported experiencing strained family relationships. The figure is
relatively higher than the 39% percent who weren’t unemployed for as long.
Mohamed Sathak A.J College of Engineering Change is the true end of all learning

 Another 43% of the long-term unemployed reported a significant effect on their

ability to achieve their career goals.
 Sadly, long-term unemployment led to 38% of these individuals losing their self-
respect and 24% seeking professional help.

Final Word

 Unemployment is a serious social and economic issue that results in a tremendous

impact on everything but is often overlooked. A stronger system of assessing
unemployment should be put in place in order to determine its causes and how to
address it better.

4. Explain the roles, features and functions of a central bank?

Reserve Bank of India, acting as an apex court of the centre, enjoys vast power and functions as per
the banking mechanism in India. It has control over the issue of banknotes and the monetary
arrangement of the country. These influences and purposes as to the issue of banknotes and currency
systems are administered by the Reserve Bank of India Act, 1934. Moreover, the Banking Regulation
Act of 1949 authorises specific power and roles to the Reserve Bank.

Main Role of RBI

The main operations are those roles that each central bank of every nation executes throughout the
world. Fundamentally, these operations are in alliance with the purposes with which the bank is
instituted. It comprises the primary operations of the Central Bank. They include the following:
Issuing the Currency Notes: Only the RBI contains the right or power or control to issue currency
notes excluding notes of one rupee and smaller denomination coins. These currency notes are lawful
tender that the RBI issues. At present, they contain denominations of Rs. 2, 5, 10, 20, 50, 100, 500,
and 2,000. The RBI further has authority to issue and withdraw and also to switch these currency
notes for different denominations. RBI further issues such notes with consonance to the security of
gold bullion, rupee coins, foreign securities, exchange bills, the government of India bonds, and
promissory notes.
Banker to commercial Banks: The central bank acting as an apex institution has compulsory powers
to direct, help and control other commercial banks in the nation. The RBI has the power to manage
the bank’s reserves and permit other banks in generating credit in the appropriate proportion. Each
commercial bank is obligated to sustain a fraction of the reserves with its parent, viz., the RBI.
Likewise, in requirement or necessity, these banks advance the RBI. Therefore, it is known to be the
lender of the last resort.
Acting as Banker for the Government: The Central Bank operating as the apex body, is required to
operate as an agent of both the state and central government. It executes different banking functions,
for instance, admitting deposits, taxes and extending payments representing the government. It
sustains government accounts, giving financial counsel to the government. It administers public debts
of the government and upholds reserves of foreign exchange in the representation of the government.
It gives a facility of overdraft to the government when it faces a financial crisis.
Mohamed Sathak A.J College of Engineering Change is the true end of all learning

Exchange Rate Management: It is a necessary function of the RBI. To sustain constancy in the outer
value of the rupee, it has to organise domestic policies in that course. Moreover, it needs to arrange
and execute the foreign exchange rate policy, which will aid in achieving the exchange rate constancy.
To sustain the exchange rate stability, it has to get demand and supply of the foreign currency (U.S
Dollar) near to each other.
Credit Control Function: Commercial banks in the country generate credit as per the demand in the
economy. Although if this credit creation is unconstrained or free, then it escorts the economy into
inflationary cycles. If credit creation is under the required limit, then it damages the development of
the economy. As a central bank of the nation, the RBI has to look for expansion with price constancy.
Therefore, it controls the credit creation ability of commercial banks by employing different credit
control tools.
Supervisory Function: The RBI has been bestowed with enormous powers for administering the
banking mechanism in the nation. It has the authority to issue a licence for instituting new banks, start
new branches, choose minimum reserves, examine the performance of commercial banks in India and
abroad, and direct and guide the commercial banks in India. It could have periodical examinations and
audits of the commercial banks in India
Functions of RBI
The reserve bank also performs several supervisory functions. It has the power to control and manage
the whole banking and financial system. A few of its supervisory functions are given below.
Granting a licence to banks: The RBI gives licence to banks for executing their business. Licence is
as well given for starting extension counters, new branches, even to shut down current branches.
Bank Inspection: The RBI gives licence to banks functioning as per the directives and in a discreet
manner without excessive risk. Additionally, it can inquire for periodical information from banks on
different constituents of assets and liabilities.
Control over NBFIs: The Non-Bank Financial Institutions are not affected by the functioning of a
monetary policy. Though, RBI has the power to issue directives to the NBFIs from time to time
concerning their operation. Through periodic examinations, it can manage the NBFIs.
Implementation of the Deposit Insurance Scheme: The RBI has instituted the Deposit Insurance
Guarantee Corporation to defend the deposits of small depositors. All bank deposits under Rs. One
lakh are insured through this corporation. The RBI operates to execute the Deposit Insurance Scheme
in case of a bank breakdown.
Conclusion
Central banks are in charge of supervising the monetary system for a country (or group of countries),
along with a broad range of other responsibilities, from supervising monetary policy to executing
specific goals, for instance, currency stability, low inflation, and full employment. The position of
the central bank has developed in significance in the last century. To guarantee the constancy of a
country’s currency, the central bank must be the watchdog and authority in the monetary and banking
systems.

5. What are the challenges and opportunities of the Indian Banking System?
Mohamed Sathak A.J College of Engineering Change is the true end of all learning

Introduction

This is a very crucial topic that talks about the economic strata of the country, as financial conditions
are important for the development of its people and their growth. The following article talks about the
Indian banking industry and the different opportunities and challenges for them.

 The Indian Banking Industry

 Challenges
 Opportunities

The Indian Banking Industry itself is a huge history, it covers all the banking practices that were
traditionally awarded by the Britishers. The time flies so fast that the nationalization of the banking
system changed to their privatization and at times like today it has changed with the increase of the
foreign banks in India. It has been a very long journey for the banking industry of the country as new
changes with time can be seen with every high and low that comes into the industry.

The Indian Banking Industry

There is a change in the dynamics of the banking system that can bring new exposure to the risks that
a business could face. That is the reason that technological use has brought a different type of
revolution to the working systems of the bank. If we compare today’s system with the system that
used to run in the old times.

With time any sector that seeks progress also has a very high possibility of facing different kinds of
challenges and opportunities along the way, the same has happened with the Banking industry of
India. The earliest bank that was set up in the country was in 1870, “The Bank of Hindustan”. Later in
the upcoming years, more banks were set up. These were the presidency banks under the Act
“Presidency Bank Act 1876”. The Reserve Bank of India was set up in India in the year 1934, also it
has been constituted that it is an apex body that will function without the major ownership of the
Government of India. In the year 1955, the RBI took complete control of the Imperial Bank of India,
and then renamed it the “State Bank of India”. Soon the State Bank of India took control over 8
different private banks from the princely states and by the year 1960, the RBI was forced to merge the
weaker banks with the stronger banks.

Challenges
During the development years of the Indian banking industry, it is obvious that it would have
experienced different levels of problems, and risks and you must have seen an increase in the level of
competition. All these developments and problems that took place have also shown their adverse
consequences that have brought loopholes in the system and resulted in the malfunctioning of the
industry in the past. Some of the issues that are faced by the banking system of the country are given
below:
 Although, there has been an increase of smaller branches of the banks in the rural areas. But
the problem is the lack of technical enhancement and important services which are available
in the bigger cities are not available for rural branches
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 There are severe concerns regarding the practices in the banking industry which are related to
the customer service as the banks are expected to give fair treatment to all of their customers
and properly attend to every one of them so that they can easily trust the system with their
assets
 With the constant increase process of globalization in the economy of the country, the banks
are faced with an intense competitive environment that makes it imperative for the banks
to enhance their systems
 The timely technological up-gradation has brought up intense competition in the Indian
banking sector. It has been indispensable for all the banks with new technology and needs up-
gradation in their services

Opportunities
Every problem or advancement brings a chance for the system to improve and gives them an
opportunity so they could learn and excel in their field. Some of the opportunities that are in the
Banking System are:
1. An impactful growth in the economy of the country.
2. The increase in client borrowing.
3. Number of increases in the branches of banks in different areas of the country.
4. The deregulation of the banking system.
5. Large checking of the customer account balances.
6. The increment in the supply of money.

Conclusion
As has been mentioned above, the Indian banking industry has developed a lot since the first bank
was set up in the country in 1870 – the Bank of Hindustan. Later on, there have been many
developments in this field that have also upgraded the system, and on the same hand brought up so
many challenges and loopholes in them too.