UPSC Prelims Practice Questions — Heavy lifting on inflation will fall upon government

Q1. With reference to the statutory flexible inflation targeting framework in India, consider the following statements: Which of the statements given above is/are correct?

  1. The numerical inflation target is fixed by the Central Government in consultation with the Reserve Bank of India, and the Monetary Policy Committee decides the policy rate needed to achieve it.
  2. If average CPI inflation goes above the upper tolerance limit in any single quarter, the Reserve Bank is deemed to have failed to meet the inflation target.
  3. When the target is deemed missed, the Reserve Bank must report to the Central Government the reasons for the failure, the remedial actions it proposes and an estimate of when the target will be achieved.
  • A. 2 and 3 only
  • B. 1, 2 and 3
  • C. 1 only
  • D. 1 and 3 only

Q2. Consider the following statements: Which of the following is correct in respect of the above statements?

  1. Central banks often raise policy rates even when the current rise in inflation is driven mainly by supply shocks in food and fuel.
  2. A persistent supply-driven rise in prices can push up inflation expectations and spill over into wages and core prices, and monetary tightening can restrain these effects.
  • A. Both Statement-I and Statement-II are correct and Statement-II explains Statement-I
  • B. Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I
  • C. Statement-I is correct, but Statement-II is incorrect
  • D. Statement-I is incorrect, but Statement-II is correct

Q3. Suppose the Central Government cuts excise duty on diesel to offset a rise in international crude prices, and keeps its expenditure plans unchanged. Consider the following possible consequences: Which of the statements given above is/are correct?

  1. Retail diesel prices rise by less than they otherwise would, which moderates freight costs that feed into consumer prices.
  2. The Centre's tax revenue falls, so its fiscal deficit widens relative to what it would otherwise have been.
  3. The current account deficit narrows, because a lower domestic tax reduces the value of crude oil imports.
  • A. 1 and 2 only
  • B. 1 and 3 only
  • C. 2 and 3 only
  • D. 1 only

Q4. International crude oil prices are rising. Oil marketing companies, which are majority-owned by the government, have kept retail petrol and diesel prices unchanged, reportedly at the Centre's behest. Which of the following inferences can validly be drawn from the above?

  1. The Union Budget's reported fiscal deficit captures the full cost of this price restraint.
  2. Part of the cost of the oil shock is being absorbed by the companies' balance sheets instead of being passed on to consumers.
  3. The price signal that would ordinarily curb domestic demand for fuel is being muted.
  4. India's crude oil import bill is unaffected by the rise in international prices because retail prices are unchanged.
  • A. 1, 3 and 4 only
  • B. 1 and 2 only
  • C. 2 and 3 only
  • D. 3 and 4 only

Q5. Consider the following assertion: Retaining headline CPI, rather than core inflation, as the formal target of monetary policy is justified in India. Which of the following statements support the above assertion?

  1. Food and fuel make up a large share of household consumption, so headline CPI better reflects the cost of living.
  2. Movements in food prices strongly shape households' expectations of future inflation.
  3. Persistent food inflation can spill over into wages and other prices, so a target that ignores food risks missing second-round effects.
  4. Headline CPI is less volatile than core inflation, so it is easier for the MPC to forecast.
  • A. 1 and 2 only
  • B. 1, 2 and 3 only
  • C. 1, 2, 3 and 4
  • D. 3 and 4 only

Q6. A conflict in West Asia causes a sustained rise in international crude oil prices. Consider the following likely effects on India: Which of the statements given above is/are correct?

  1. Higher diesel costs raise freight charges, so prices of goods that are not themselves fuels can also rise.
  2. A larger oil import bill increases demand for foreign currency and puts pressure on the rupee to depreciate.
  3. Since crude is largely priced in US dollars, a weaker rupee raises the rupee cost of the same quantity of imported oil.
  • A. 1 and 3 only
  • B. 1 and 2 only
  • C. 2 and 3 only
  • D. 1, 2 and 3

Q7. Consider the following statements: Which of the following is correct in respect of the above statements?

  1. A sharp rise in international crude oil prices tends to widen India's current account deficit.
  2. When oil marketing companies hold retail fuel prices unchanged, the impact of a crude price rise on domestic consumer prices is delayed.
  • A. Both Statement-I and Statement-II are correct and Statement-II explains Statement-I
  • B. Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I
  • C. Statement-I is correct, but Statement-II is incorrect
  • D. Statement-I is incorrect, but Statement-II is correct