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An economy is facing inflationary pressures and the central bank of the country has been asked to control the situation. Arrange the action and result in sequential order.

(A) Credit has become costlier and people stop borrowing.

(B) Increase in Repo rate by the central bank.

(C) Reduction in the money supply and aggregate demand falls.

(D) Increase in the market lending rate by commercial banks.

Choose the correct answer from the options given below:

Solution

✅ Correct Option: 4

Option 1 -> Incorrect sequence - starts with the consequence (A) rather than the central bank's action.

Option 2 -> Incorrect sequence - starts with consequence (A) and places central bank action (B) in the middle.

Option 3 -> Incorrect sequence - ends with (A) when it should be (C) as the final outcome.

Option 4 -> Correct sequence - follows the logical chain of monetary policy transmission.


Hence, Option 4: (B), (D), (A), (C) -> This represents the correct transmission mechanism of contractionary monetary policy: First, the central bank increases the Repo rate (B) as a policy measure. This leads commercial banks to increase their market lending rates (D) since their cost of borrowing from the central bank has risen. As a result, credit becomes costlier and people reduce borrowing (A). Finally, this reduction in borrowing leads to a decrease in money supply and aggregate demand falls (C), thereby controlling inflation. This sequential chain demonstrates how monetary policy works through the banking system to affect the real economy. -> correct

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