Money, banking, monetary policy and inflation: previous-year questions
76 real UPSC Prelims questions (2011–2026) with the official answer and a clear explanation. 16 of them came in the last five papers.
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Questions per year, counted from the official papers.
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Consider the following liquid assets :
- 1. Demand deposits with the banks
- 2. Time deposits with the banks
- 3. Savings deposits with the banks
- 4. Currency
The correct sequence of these assets in the decreasing order of liquidity is
Answer (d) & explanation
The order 4–1–3–2 is correct (d). Currency is the most liquid asset, since it can be spent at once (4). Demand deposits in current accounts can be withdrawn at any time by cheque or transfer (1). Savings deposits are also withdrawable but have some limits on transactions (3). Time deposits (fixed deposits) are locked in for a period and carry penalties for early withdrawal, so they are the least liquid (2). (a), (b) and (c) give the wrong order.
Notice the money measures: M1 = currency with the public + demand deposits + other deposits with RBI; M3 (broad money) adds time deposits. Savings deposits are counted as demand deposits in M1. The more liquid the asset, the lower its interest. Trap: (b) puts demand deposits last.
Answer as per the official UPSC answer key.
In the context of Indian economy, ‘Open Market Operations’ refers to
Answer (c) & explanation
Purchase and sale of government securities by the RBI is correct (c). Open Market Operations are the RBI's buying and selling of government securities in the market to manage liquidity. Buying securities pays out money and adds liquidity; selling them absorbs money. (a) is wrong: banks borrowing from the RBI happens through the repo window or Marginal Standing Facility. (b) is wrong: bank lending to industry is ordinary credit, not OMO. (d) fails because (c) is correct.
Notice the variants: 'Operation Twist' (2019–20) bought long-term and sold short-term bonds at the same time, and G-SAP (2021) was a pre-announced bond-buying programme. OMOs are part of quantitative monetary tools, with CRR and SLR. Trap: (a) is a liquidity tool too, but not OMO.
Answer as per the official UPSC answer key.
Priority Sector Lending by banks in India constitutes the lending to
Answer (d) & explanation
All of the above is correct (d). Banks must lend a set share of their credit to priority sectors, which include agriculture (a), micro and small enterprises (b) and weaker sections (c), along with education, housing, export credit, social infrastructure and renewable energy. So each single option is only part of the answer.
Notice the targets: domestic scheduled commercial banks must give 40% of adjusted net bank credit to priority sectors, including 18% to agriculture (10% to small and marginal farmers), 7.5% to micro enterprises and 12% to weaker sections. Small finance banks have a 60% target, raised for some. Shortfalls go to the RIDF with NABARD, and Priority Sector Lending Certificates can be traded. The RBI revised the framework in 2025. Trap: picking one familiar sector misses the 'all' option.
Answer as per the official UPSC answer key.
A rise in general level of prices may be caused by
- 1. an increase in the money supply
- 2. a decrease in the aggregate level of output
- 3. an increase in the effective demand
Select the correct answer using the codes given below.
Answer (d) & explanation
All three are correct (d). Prices rise when more money chases fewer goods. An increase in the money supply puts more money in people's hands (1). A decrease in output, from a drought or supply shock, cuts the goods available (2). An increase in effective demand, the demand backed by purchasing power, pushes prices up (3). So options (a), (b) and (c) leave out real causes.
Notice the types: demand-pull inflation (1, 3) and cost-push or supply-side inflation (2), such as the vegetable price spikes from erratic monsoons in India. The quantity theory of money (MV = PT) links money supply to prices. The RBI's 4% CPI target under flexible inflation targeting guides policy. Trap: all three are textbook causes.
Answer as per the official UPSC answer key.
Supply of money remaining the same when there is an increase in demand for money, there will be
Answer (b) & explanation
An increase in the rate of interest is correct (b). The rate of interest is the price of money. If the demand for money rises while the supply stays the same, money becomes scarcer and its price, the interest rate, rises, in line with Keynes's liquidity preference theory. (a) is wrong: a higher interest rate may later cool prices, but the direct result is a rate rise. (c) is the opposite. (d) is wrong: income and employment are not directly raised; higher rates may even slow investment.
Notice the policy link: the RBI manages liquidity so that the overnight call money rate stays near the repo rate. When demand for money spikes, as at advance-tax time each quarter, short-term rates jump. Trap: (a) describes a possible later effect, not the immediate one.
Answer as per the official UPSC answer key.
Which of the following grants/grant direct credit assistance to rural households?
- 1. Regional Rural Banks
- 2. National Bank for Agriculture and Rural Development
- 3. Land Development Banks
Select the correct answer using the codes given below.
Answer (c) & explanation
Regional Rural Banks and Land Development Banks are correct (c). Regional Rural Banks (1975) lend directly to small farmers, artisans and rural households (1). Land Development Banks, now called Primary Cooperative Agriculture and Rural Development Banks, give long-term loans to farmers for land improvement, wells and machinery (3). Item 2 is wrong: NABARD is an apex development bank that refinances these banks and cooperatives; it does not lend directly to households. So (a), (b) and (d) fail.
Notice the structure: NABARD (1982) was set up on the Shivaraman Committee's advice and manages the RIDF. RRBs are owned by the Centre (50%), sponsor bank (35%) and State (15%), and were amalgamated to 28 from May 2025. Trap: NABARD sounds rural, but it lends to banks, not people.
Answer as per the official UPSC answer key.
The Reserve Bank of India regulates the commercial banks in matters of
- 1. liquidity of assets
- 2. branch expansion
- 3. merger of banks
- 4. winding-up of banks
Select the correct answer using the codes given below.
Answer (d) & explanation
All four are correct (d). Under the Banking Regulation Act, 1949, the RBI regulates banks' liquidity through the CRR and SLR (1), licenses and controls branch expansion (2), approves mergers and amalgamations, and can impose schemes on weak banks (3), and can apply for the winding up of a bank or place it under a moratorium (4). So options (a), (b) and (c) leave out real powers.
Notice the recent uses: the RBI-led rescue of Yes Bank (2020), the merger of Lakshmi Vilas Bank with DBS (2020), and the 2020 amendment bringing cooperative banks under fuller RBI supervision. Branch authorisation has since been liberalised for scheduled banks. Deposit insurance up to ₹5 lakh comes from DICGC. Trap: winding up seems a court matter, but RBI starts it.
Answer as per the official UPSC answer key.
An increase in the Bank Rate generally indicates that the
Answer (d) & explanation
A tight money policy is correct (d). Raising the Bank Rate makes central-bank credit costlier, so banks raise their own lending rates and credit shrinks. This is a tight or dear money policy, used to fight inflation. (a) is wrong: market interest rates tend to rise, not fall. (b) is wrong: the central bank still lends, only at a higher rate. (c) is wrong: an easy money policy would cut rates.
Notice the present tools: the repo rate is now the main signal, with the Bank Rate aligned to the Marginal Standing Facility rate. The RBI raised the repo rate by 250 basis points in 2022–23 to fight inflation, then cut it through 2025. The Monetary Policy Committee has six members. Trap: higher rates mean tighter, not easier, money.
Answer as per the official UPSC answer key.
The Reserve Bank of India (RBI) acts as a bankers’ bank. This would imply which of the following?
- 1. Other banks retain their deposits with the RBI.
- 2. The RBI lends funds to the commercial banks in times of need.
- 3. The RBI advises the commercial banks on monetary matters.
Select the correct answer using the codes given below :
Answer (d) & explanation
All three are correct (d). As the bankers' bank, the RBI does for banks what a bank does for its customers. Banks keep part of their deposits with it as cash reserves (CRR) (1). It lends to banks in need, through the repo window, the Marginal Standing Facility, and as lender of last resort (2). It advises and guides banks on monetary and credit matters (3). So options (a), (b) and (c) leave out real functions.
Notice the other roles: issuer of currency, banker to the government, regulator of banks and NBFCs, and manager of foreign exchange. The RBI was set up in 1935 on the Hilton Young Commission's advice and nationalised in 1949. Trap: all three are textbook features of a central bank.
Answer as per the official UPSC answer key.
Which of the following measures would result in an increase in the money supply in the economy?
- 1. Purchase of government securities from the public by the Central Bank
- 2. Deposit of currency in commercial banks by the public
- 3. Borrowing by the government from the Central Bank
- 4. Sale of government securities to the public by the Central Bank
Select the correct answer using the codes given below :
Answer (c) & explanation
Items 1 and 3 are correct (c). When the central bank buys government securities from the public, it pays with new money, so supply rises (1). When the government borrows from the central bank, the RBI creates new money (monetisation of deficit), so supply rises (3). Item 4 is the reverse: selling securities absorbs money. Item 2 is neutral: depositing cash in a bank only changes money's form from currency to deposits; UPSC treats it as no increase, though it could later enable more lending. So (a), (b) and (d) fail.
Notice the tools: these are open market operations. The 1997 agreement ended automatic monetisation through ad hoc Treasury Bills, and the FRBM Act bars RBI from primary market purchases except in special cases. Trap: deposits feel like 'more money', but the total is unchanged.
Answer as per the official UPSC answer key.
The basic aim of Lead Bank Scheme is that
Answer (c) & explanation
Option (c) is correct. Under the Lead Bank Scheme, started in 1969 on the Gadgil Study Group and Nariman Committee recommendations, each district was assigned to one bank as its lead bank. That bank takes charge of credit planning and coordinates banks and government agencies for intensive development of the district. (a) is wrong: opening offices everywhere was not the aim. (b) is wrong: the scheme sought coordination, not competition. (d) is wrong: deposit mobilisation was not the core goal.
Notice the machinery: the District Consultative Committee and the State Level Bankers' Committee (SLBC), convened by a convenor bank, review credit plans; the Potential Linked Credit Plans are prepared by NABARD. The RBI reviewed the scheme in 2017. Trap: 'big banks' sounds right, but the idea is district adoption.
Answer as per the official UPSC answer key.
India has experienced persistent and high food inflation in the recent past. What could be the reasons ?
- 1. Due to a gradual switchover to the cultivation of commercial crops, the area under the cultivation of food grains has steadily decreased in the last five years by about 30%.
- 2. As a consequence of increasing incomes, the consumption patterns of the people have undergone a significant change.
- 3. The food supply chain has structural constraints.
Which of the statements given above are correct ?
Answer (b) & explanation
Statements 2 and 3 are correct (b). As incomes rose in the 2000s, people shifted their diets towards protein-rich foods, milk, eggs, meat, fruits and vegetables, whose supply did not keep pace, pushing up prices (2). The food supply chain had structural constraints: poor storage and cold chains, many middlemen, APMC market restrictions and wastage (3). Statement 1 is wrong: the area under foodgrains did not fall by 30% in five years; it stayed roughly steady at about 120-125 million hectares. So options (a), (c) and (d) fail.
Notice the policy response over the years: e-NAM (2016), the Operation Greens scheme for tomato, onion and potato, cold-chain support under PM Kisan SAMPADA, and buffer stocks of pulses and onions. CPI food inflation is measured through the Consumer Food Price Index. Trap: an exaggerated figure like '30%' usually signals a false statement.
Answer as per the official UPSC answer key.
A rapid increase in the rate of inflation is sometimes attributed to the “base effect”. What is “base effect” ?
Answer (c) & explanation
The answer is (c). Inflation is usually measured as the percentage rise in prices over the same month of the previous year. The base effect is the impact that last year's price level (the base) has on this calculation. If prices were unusually low last year, even a normal rise this year shows up as high inflation; if prices were unusually high last year, this year's inflation looks low. Options (a) and (b) describe real causes of inflation (supply shocks and demand surges), not the statistical base effect, and (d) is wrong because (c) fits.
Notice how often it appears: during 2021, inflation figures looked high partly because prices had crashed during the 2020 lockdown, a classic base effect. The RBI often cites favourable or unfavourable base effects in policy statements. Trap: the base effect is about arithmetic, not new price pressures.
Answer as per the official UPSC answer key.
Why is the offering of “teaser loans” by commercial banks a cause of economic concern ?
- 1. The teaser loans are considered to be an aspect of sub-prime lending and banks may be exposed to the risk of defaulters in future.
- 2. In India, the teaser loans are mostly given to inexperienced entrepreneurs to set up manufacturing or export units.
Which of the statements given above is/are correct ?
Answer (a) & explanation
Statement 1 only is correct (a). Teaser loans were home loans with a low fixed rate for the first few years, after which the rate reset sharply higher. Borrowers who qualified only at the low rate might default later, a risk similar to sub-prime lending that caused the 2008 US crisis (1). The RBI therefore raised provisioning and risk weights on such loans in 2010–11. Statement 2 is wrong: they were housing loans to individuals, not loans to new entrepreneurs or export units. So (b), (c) and (d) fail.
Notice the wider lesson: lending based on rising house prices rather than repayment capacity creates bubbles. Trap: statement 2 invents a borrower group to make it sound developmental.
Answer as per the official UPSC answer key.
Economic growth is usually coupled with
Answer (b) & explanation
Inflation is correct (b). When an economy grows, incomes and demand rise faster than supply can adjust, so prices usually rise moderately. This mild inflation often comes with growth; the Phillips curve idea links lower unemployment to higher inflation. (a) is wrong: deflation, a fall in prices, usually comes with slumps. (c) is wrong: stagflation means low growth with high inflation, the opposite of growth. (d) is wrong: hyperinflation is a runaway rise in prices, a breakdown, not normal growth.
Notice India's framework: the RBI targets 4% CPI inflation with a band of 2–6% under the flexible inflation targeting regime (2016), now retained for 2026–31. Trap: 'usually coupled' asks for the typical, moderate case.
Answer as per the official UPSC answer key.
The lowering of Bank Rate by the Reserve Bank of India leads to
Answer (a) & explanation
More liquidity in the market is correct (a). The Bank Rate is the rate at which the RBI lends to banks on a longer-term basis without collateral of government securities. Cutting it makes borrowing from the RBI cheaper, so banks can lend more at lower rates, and liquidity rises. (b) and (c) are wrong for that reason. (d) is wrong: lower policy rates tend to lower deposit rates, so deposits do not rise because of the cut.
Notice the present practice: the repo rate is now the main policy signal; the Bank Rate is aligned with the Marginal Standing Facility rate (repo + 0.25%) and is used mainly for penal rates. Other tools: CRR, SLR, the Standing Deposit Facility and open market operations. Trap: deposits fall, not rise, when rates are cut.
Answer as per the official UPSC answer key.