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Deciphering the Economics

Important Questions of Money and Banking

20 Money and banking important questions class 12th macroeconomics

Money and Banking

  1. The government of India recently launched the “Jan Dhan Yojana” aimed at every household in the country to have at least one bank account. Explain how deposits made under this scheme are going to affect the National Income of the country.

Ans. The “Jan Dhan Yojana” initiative launched by the government of India aims to provide banking access to every household in the country, ensuring that each household has at least one bank account. Deposits made under this scheme can positively impact the National Income of India in several ways.

Firstly, increased savings resulting from the scheme can lead to higher investment, which is a key driver of economic growth and can contribute to an increase in the National Income. Secondly, the scheme promotes financial inclusion by providing banking access to households in rural and remote areas, allowing them to participate more actively in the formal economy. This can lead to higher economic activity and potential income generation.

Furthermore, access to banking services can improve financial literacy and encourage households to save and invest wisely, resulting in increased disposable income and higher consumption levels. This, in turn, can have a positive impact on the National Income. Additionally, the increased deposits in banks can provide a stable source of funds for banks to lend for infrastructure development projects. This can lead to improved infrastructure, further stimulating economic growth and contributing to the National Income.

Overall, the “Jan Dhan Yojana” can have a positive impact on the National Income of India by promoting savings, financial inclusion, consumption, and infrastructure development.

2. The growth of the Indian Economy requires investments. How the process of credit creation can promote the growth of the Indian economy.

Ans. The process of credit creation is crucial for India’s economic growth as it facilitates investments. Banks lend money to businesses and individuals, enabling them to expand, invest in technology, and create new products. This leads to higher production, job creation, and overall economic growth.

Access to credit encourages entrepreneurship by providing financial resources to start businesses and fostering innovation and competition. Consumer credit boosts spending, stimulating demand, and increasing production and employment.

Credit creation finances infrastructure projects, improving connectivity, reducing costs, and attracting investment. It also supports agriculture by providing farmers with credit for inputs, increasing productivity, ensuring food security, and raising income levels.

Additionally, credit creation enables investment in assets like stocks and real estate, diversifying portfolios and creating long-term wealth for sustainable growth.

In conclusion, credit creation is key to India’s economic growth, promoting investment, entrepreneurship, consumer spending, infrastructure development, and wealth creation.

3. The commodity value (Intrinsic Value) of money has never been greater than the face (or money value). Is it true?

Ans. “The commodity value of money has never been greater than the face value” is false.
India has historically utilized coins made of precious metals, such as copper, silver, and gold, whose commodity values were frequently higher than their face values. A one-gram gold coin, for instance, would have a commodities value equal to the going rate for one gram of gold on the market, which might be more than the face value shown on the coin.

4. What is High-powered money? How does it act as the monetary base of the economy?

Ans. High-powered money, or the monetary base, is the total amount of money issued by the central bank, including currency in circulation and bank reserves. It serves as the foundation for the banking system to create additional money through lending. In India, the RBI manages high-powered money, and it influences the money supply by determining how much banks can lend based on their reserves. For example, if the RBI injects ₹1,000 crore into the economy, banks can lend out a portion, creating new deposits and expanding the money supply.

Symbolically, H = C + RR + ER Where,

C = represent currency

RR = Required reserves

ER = The Excess reserves

5. Fiat money is the same as fiduciary money. True or False.

Ans. False.

Fiat money and fiduciary money are not the same. Fiat money is a currency that has value because a government maintains it as a medium of exchange, while fiduciary money is backed by the credit of the issuing authority, such as a government or a bank, rather than by a physical commodity. While fiat money is a type of fiduciary money, not all fiduciary money is fiat money.

6. Gross Demand deposits are not a part of the money supply while net deposits are. True or False.

Ans. True.

Gross demand deposits include interbanking claims (The loans or sums owing between banks are referred to as inter-banking claims. These claims occur when a bank lends money to another bank, usually to satisfy regulatory obligations or manage short-term liquidity). In contrast, net demand deposits do not include inter-banking claims. Hence, only net demand deposits are taken as a part of the money supply, not the gross deposits.

7. Term deposits are near money, and therefore should be treated as a component of the M1 supply of money.

Ans. False.

M1 supply of money includes only the most liquid components of the money supply. There are those components (like currency with the people) that can be used for the sale and purchase of goods at any time. Term deposits are not so liquid and therefore, not included in the M1 supply of money.

8. While performing their primary function of accepting deposits and making advances, the commercial banks happen to be the suppliers of money. Explain.

OR

Commercial banks do not have note-issuing authority but they do contribute to the money supply in the economy. Comment.

Ans. Commercial banks are the suppliers of money because they play a crucial role in creating and circulating money in the economy. This process is known as credit creation or money creation. When commercial banks accept deposits from customers, they are essentially taking in money and promising to repay it on demand or as per the terms of the deposit agreement.

However, banks do not keep all the deposited money in their vaults. Instead, they keep a portion of it as reserves and lend out the rest to borrowers. This lending process creates new money in the form of bank deposits.

For example, if a bank receives a deposit of ₹100 from a customer with a reserve requirement of 10%, it can lend out ₹90 to a borrower. The borrower will then deposit the ₹90 in their bank account, and the process repeats. In this way, the original ₹100 deposit can result in a total of ₹1,000 being created in the banking system (assuming a reserve requirement of 10%).

By making advances (loans) to borrowers, commercial banks increase the money supply in the economy, effectively acting as suppliers of money. This process of credit creation is a key function of commercial banks and plays a vital role in the functioning of the economy.

9. Why is RBI (Central Bank), sometimes reluctant to lower the repo rate even when investment is low because of the high market rate of interest?

Ans. The RBI is reluctant to lower the repo rate in a situation when the existing rate of inflation is high and is expected to rise further. A cut in repo rate allows commercial banks to build up cash reserves and increase their capacity to create credit. If the supply of credit/money increases, the inflation rate starts multiplying leading to hyperinflation.

10. If CRR is scrapped as a legal requirement, do you think the banks can create an unlimited amount of money supply.

Ans. No.

Even if CRR is scrapped as a legal requirement, commercial banks must continue to hold some cash reserves as a percentage of their demand deposits. Because, in the absence of these reserves, the banks may sink into a ‘crisis of confidence’. People may start withdrawing their deposits from the banks in mass and the banks will simply have no reserves to cope with the withdrawals. If CRR is not fixed by Apex Bank, the bank on its own must hold cash reserves based on its historical experience, as to how much of cash reserves should be enough to cope with the routine cash withdrawals by the depositors.

11. How is quantitative credit control different from qualitative credit control?

Ans. Quantitative credit control refers to overall credit control in the economy, affecting all the sectors of the economy equally and without discrimination. Qualitative credit control refers to selective credit control that focuses on the allocation of credit to different sectors of the economy. The flow of credit is encouraged to the priority sectors, while it is discouraged to the non-priority sectors (particularly those engaged in speculative business activity).

12.  Why has the government sometimes failed to combat inflation even when a series of monetary measures are available with the central bank?

Ans. Monetary measures for combating inflation focus largely on moderating the demand for goods and services by making the availability of credit costlier and more difficult. It does not address the supply side of the problem.

While the fact of the matter is that in countries sometimes inflation has often been triggered by low market supplies. Unless supplies are boosted, we shall continue to wrestle with inflation without taming it.

 13. Secondary deposits of a commercial bank are always less than its primary deposits. True or False.

Ans. False.

Secondary deposits are many times more than the primary deposits of a commercial bank. Because primary deposits are cash deposits. A commercial bank can park its cash with RBI as ‘cash reserves’. It can legally create secondary deposits (by way of loans) many times more than its cash reserves.

 14. Is it correct that when margins are raised, demand for loans is negatively impacted?

Ans. The given statement is correct.

When margins are raised, the difference between the market value of the security offered for loans and the value of loans granted becomes high. It is now expensive for the people to take loans from the banks. Therefore, demand for loans reduces in the economy.

15. To boost the falling demand in the economy, the Central Bank recently reduced the Repo rate. Elaborate the rationale behind the steps taken by the central bank.

Ans. The central bank reduced the repo rate to boost falling demand in the economy. This decision aims to stimulate investment by lowering borrowing costs for businesses and individuals, encouraging them to invest and spend more. It also supports credit growth and consumption, essential for economic expansion. Additionally, the central bank monitors inflation expectations closely to ensure that reducing the repo rate does not lead to runaway inflation, thus maintaining price stability. Overall, the reduction in the repo rate is a monetary policy measure to counteract economic slowdowns and support growth.

16. Assess the impact of technological innovations such as blockchain and cryptocurrencies on the banking sector. How do these innovations challenge traditional banking models, and what opportunities do they present?

Ans. Technological innovations such as blockchain and cryptocurrencies have the potential to disrupt the banking sector by offering new ways of transferring value and recording transactions. Blockchain technology, in particular, could streamline payment processing and reduce transaction costs for banks. However, cryptocurrencies also pose challenges such as regulatory uncertainty, volatility, and security risks. Overall, these innovations present opportunities for banks to improve efficiency and customer service but also require them to adapt to a rapidly changing technological landscape.

17. Critically evaluate the role of central banks in financial crises. How have central banks responded to recent financial crises, and what lessons can be learned from their actions?

Ans. Central banks play a crucial role in managing financial crises by providing liquidity to the banking system, acting as lenders of last resort, and implementing monetary policy measures to stabilize the economy. They have responded to recent financial crises by lowering interest rates, providing emergency liquidity support, and implementing unconventional monetary policy measures such as quantitative easing. Lessons learned from their actions include the importance of early intervention, coordination with other policymakers, and the need for effective communication to maintain market confidence.

18. Discuss the role of the central bank in regulating and supervising commercial banks. How does this help maintain financial stability?

Ans. The central bank regulates and supervises commercial banks to ensure their soundness and stability. It sets prudential regulations such as capital adequacy requirements, liquidity requirements, and asset quality standards to ensure that banks operate safely and responsibly. By supervising banks and enforcing regulations, the central bank helps maintain financial stability and protect depositors’ interests.

19. Evaluate the impact of demonetization on the Indian economy. How has demonetization affected different sectors of the economy, such as agriculture, industry, and services?

Ans. Demonetization refers to the process of withdrawing a currency from circulation and replacing it with a new currency. In 2016, the Indian government demonetized ₹500 and ₹1000 banknotes to curb black money, corruption, and counterfeit currency. The impact of demonetization on the Indian economy has been mixed. While it led to a temporary cash crunch and a slowdown in economic activity, it also had positive effects such as increased digital transactions and formalization of the economy. The impact of demonetization on different sectors of the economy has varied, with agriculture, industry, and services experiencing different levels of disruption and recovery.

20. Analyze the impact of inflation on the value of money. How does inflation erode the purchasing power of money, and what measures can individuals and businesses take to protect themselves against inflation?

Ans. Inflation refers to the rate at which the general level of prices for goods and services rises, leading to a decrease in the purchasing power of money. As inflation erodes the value of money over time, individuals and businesses may take measures to protect themselves against its effects. These measures include investing in assets that appreciate over time, such as real estate and stocks, and indexing wages and prices to inflation. Additionally, central banks may use monetary policy tools to control inflation and maintain price stability.

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