Money & Inflation — PPSC previous year questions

Stagflation is stagnation plus inflation — an economy with high inflation together with high unemployment and little or no growth, as seen in the West after the 1973 oil shock. It contradicts the simple Phillips-curve trade-off, since inflation and unemployment rise together instead of moving in opposite directions.

High inflation makes the central bank tighten monetary policy. It raises the repo rate and CRR, and sells securities through open market operations. So the money supply is reduced and demand cools. Inflation itself means too much money chasing goods. The policy response works in the opposite direction.

Only two measures raise the money supply: when banks expand credit they create new deposits, and when the government borrows from the RBI new money is printed (monetisation). Selling securities to the public pulls money out of circulation, and raising the repo or MSF rate makes borrowing costlier, which shrinks credit.

'Too much money chasing too few goods' is the classic description of demand-pull inflation. Aggregate demand outruns what the economy can supply, so prices are pulled upward. Cost-push inflation instead starts on the supply side, when input costs such as wages or crude oil rise. Stagflation is high inflation together with stagnant output and unemployment. The Great Depression was a period of deflation, not inflation.

The reverse repo rate is the interest RBI pays banks for parking money with it. Raising it makes banks park more money with RBI, so the money in the market falls and prices come under control; both statements say the opposite, so neither is correct.

The promissory clause, signed by the RBI Governor, means the note is legal tender for the amount printed on it: under Section 26 of the RBI Act, 1934 every bank note is legal tender for its face value and is guaranteed by the Central Government. Historically the clause recorded the RBI's undertaking to exchange the note for coin or other notes of equal value, which is why (a) is only a partial truth; today the legal meaning is that the note itself settles a debt of that amount. Banks may refuse a suspect or mutilated note, and the holder owes nothing to anyone for accepting it.

The Wholesale Price Index (WPI), published monthly by the Office of the Economic Adviser (DPIIT), was India's headline inflation gauge till 2014 and is the only nationwide measure among the options, so it is the answer. The CPI for urban non-manual employees (discontinued in 2008) and the CPI for agricultural workers are narrow series used for fixing dearness allowance, and a national income deflator is not a policy index. Since the 2014 Urjit Patel framework and the Monetary Policy Committee of 2016, the RBI measures and targets inflation by the CPI (Combined), at 4 per cent with a band of 2 to 6 per cent; WPI is still published but is no longer the policy anchor.

Inflation is classically described as too much money chasing too few goods: aggregate demand outruns aggregate supply and the general price level rises. When supply exceeds demand (option c) prices tend to fall, which is deflation, and money growing in step with increased supply of goods (option b) does not push prices up.

Inflation rises when demand or costs go up. A cut in policy rates makes credit cheaper and raises spending, so 1 is inflationary. When the RBI buys back government securities in open-market operations, it injects money, so 2 is inflationary. Higher MGNREGA wages raise rural buying power and push up the wage floor for other labour, so 3 is inflationary. A cut in indirect taxes such as excise or VAT lowers the price of goods. That is disinflationary, so 4 is not a cause. So 1, 2 and 3.

Inflation erodes the purchasing power of the rupee. So the domestic currency tends to depreciate (1 correct). Domestic goods become costlier abroad, and a weaker rupee makes imports dearer. So exports lose competitiveness (2 correct). To curb inflation the central bank raises policy rates. So the cost of borrowing rises, not falls (3 wrong). Bondholders lose, because fixed interest and principal are repaid in money of lower value (4 wrong). So 1 and 2 only.