Previous Year Question
Consider the following statements:
Statement-I: In the post-pandemic recent past, many Central Banks worldwide had carried out interest-rate hikes.
Statement-II: Central Banks generally assume that they have the ability to counteract rising consumer prices through monetary-policy means.
Which one of the following is correct in respect of the above statements?
Both Statement-I and Statement-II are correct and Statement-II is the correct explanation for Statement-I.
Both Statement-I and Statement-II are correct and Statement-II is not the correct explanation for Statement-I.
Statement-I is correct, but Statement-II is incorrect.
Statement-I is incorrect, but Statement-II is correct.
Correct Answer: A
Detailed Solution
Statement-I is correct. After the pandemic, the reopening of economies, rapid recovery in demand for goods and services, supply-chain disruptions and increases in food and energy prices resulted in higher consumer-price inflation in several countries. In response, many Central Banks increased their policy interest rates.
In India, the RBI increased the Policy Repo Rate from 4.00% to 6.50% between May 2022 and February 2023—a cumulative increase of 250 basis points.
Statement-II is also correct. Central Banks use the following monetary-policy transmission mechanism to counter rising consumer prices:
An increase in the policy rate raises money-market rates and banks’ lending rates.
Costlier credit reduces interest-sensitive consumption and investment.
Growth in aggregate demand slows.
Demand-induced price pressures and inflation begin to moderate.
Rate increases also help control inflation expectations and limit second-round price and wage effects.
Monetary policy cannot directly remove supply-side problems such as crude-oil shortages, crop failures or supply-chain disruptions. Nevertheless, it can counter consumer-price inflation by moderating demand, preventing inflation from becoming generalised and anchoring inflation expectations.
Thus, Central Banks raised interest rates because they sought to counter rising consumer prices through monetary-policy measures. Statement-II is, therefore, the correct explanation for Statement-I.