UPSC Prelims Practice Questions — Nobel lesson: value of stabilisation models

Q1. With reference to India's statutory flexible inflation targeting framework under the amended Reserve Bank of India Act, 1934, consider the following statements: Which of the statements given above is/are correct?

  1. The inflation target is determined by the Central Government in consultation with the RBI, and not by the Monetary Policy Committee itself.
  2. All members of the Monetary Policy Committee are external experts appointed by the Central Government, so that RBI officials do not vote on the policy rate.
  3. If the inflation target is missed, the RBI must explain the reasons and its proposed remedial actions in a report submitted to Parliament.
  • A. 2 and 3 only
  • B. 1 only
  • C. 1 and 3 only
  • D. 1 and 2 only

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

  1. Under India's flexible inflation targeting framework, CPI inflation running somewhat above the 4 per cent target in a particular quarter does not by itself amount to a failure to meet the target.
  2. The amended RBI Act places growth on an equal footing with price stability as the primary objective of monetary policy.
  • 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. Consider the following statements: Which of the following is correct in respect of the above statements?

  1. India's inflation target is defined in terms of headline CPI inflation rather than core inflation.
  2. In India, food and fuel price movements are largely driven by supply shocks that do not respond directly to monetary policy.
  • 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

Q4. A central bank with a strong record of credibility leaves its current policy rate unchanged but announces that it expects to keep the rate low for an extended period. With reference to this announcement, consider the following statements: Which of the statements given above is/are correct?

  1. Longer-term market interest rates may decline even though the current policy rate has not changed.
  2. Households and firms may increase spending today because they expect borrowing costs to remain low in the future.
  3. Such guidance can move longer-term rates only to the extent that markets believe the central bank will actually follow through on it.
  • A. 1 and 2 only
  • B. 1 and 3 only
  • C. 2 and 3 only
  • D. 1, 2 and 3

Q5. Consider the following observations about the 1970s: I. Oil prices rose sharply following the 1973 OPEC embargo. II. Several advanced economies experienced high inflation together with high unemployment. III. Macroeconomic models built on an apparently stable inverse relationship between inflation and unemployment failed to anticipate this outcome. Which of the following inferences can be drawn from the above observations?

  1. Monetary policy cannot influence output and employment even in the short run.
  2. A rise in unemployment does not necessarily mean that inflation will fall.
  3. An inflation–unemployment relationship estimated from past data may not remain stable when economic conditions and behaviour change.
  • A. 1 and 2 only
  • B. 1, 2 and 3
  • C. 2 and 3 only
  • D. 3 only

Q6. With reference to the New Keynesian and New Classical approaches to macroeconomics, consider the following statements: Which of the statements given above is/are correct?

  1. New Classical economics attributes the short-run real effects of monetary policy mainly to sticky prices and wages.
  2. New Keynesian models combine optimising, forward-looking households and firms with frictions such as slow adjustment of prices and wages, so that markets do not clear instantly.
  3. New Classical economics holds that fully anticipated monetary policy can reliably lower unemployment because workers are slow to notice price changes.
  • A. 2 only
  • B. 1 and 3 only
  • C. 2 and 3 only
  • D. 1 and 2 only

Q7. According to New Keynesian macroeconomics, an unexpected cut in the policy interest rate tends to raise real output for a while, but this effect does not persist indefinitely. Which of the following best explains this?

  • A. Lower interest rates permanently enlarge the capital stock, but households then choose to work fewer hours.
  • B. Prices are fully flexible in the short run, but long-term wage contracts later absorb the monetary stimulus.
  • C. Prices and wages adjust slowly at first, but once they fully adjust, money ends up affecting only nominal variables.
  • D. People form expectations by looking only at past inflation, so the effect fades once the inflation data catch up.

Q8. Suppose estimates show that an economy's actual output is well above its potential output, unemployment is unusually low and inflation is rising. Which of the following responses is most consistent with counter-cyclical stabilisation policy?

  • A. Hold the policy rate steady, since a positive gap signals spare capacity in the economy
  • B. Raise the policy rate to slow aggregate demand back towards the economy's potential output
  • C. Cut the policy rate so that potential output rises enough to match the actual output
  • D. Increase government spending to sustain aggregate demand at its present elevated level