Given below are two statements: Statement I: Deficit financing cannot create inflation in an economy. Statement II: If RBI reduces the cash reserve ratio, credit creation will decline. In light of the above statements, choose the most appropriate answer from the options given below:
Question:
Given below are two statements: Statement I: Deficit financing cannot create inflation in an economy. Statement II: If RBI reduces the cash reserve ratio, credit creation will decline. In light of the above statements, choose the most appropriate answer from the options given below:
Given below are two statements: Statement I: Deficit financing cannot create inflation in an economy. Statement II: If RBI reduces the cash reserve ratio, credit creation will decline. In light of the above statements, choose the most appropriate answer from the options given below:
Options
Answer: (2) Both Statement I and Statement II are incorrect
Explanation:
Statement I is incorrect: Deficit financing — the practice of government spending more than its revenue and covering the gap by borrowing or printing money — is a well-known cause of inflation. When money supply increases without a corresponding increase in goods and services, prices rise. Statement II is incorrect: If RBI REDUCES (lowers) the Cash Reserve Ratio (CRR), banks are required to maintain less cash with the RBI, freeing up more funds for lending — this INCREASES credit creation, not declines it. A higher CRR reduces credit creation.
Explanation:
Statement I is incorrect: Deficit financing — the practice of government spending more than its revenue and covering the gap by borrowing or printing money — is a well-known cause of inflation. When money supply increases without a corresponding increase in goods and services, prices rise. Statement II is incorrect: If RBI REDUCES (lowers) the Cash Reserve Ratio (CRR), banks are required to maintain less cash with the RBI, freeing up more funds for lending — this INCREASES credit creation, not declines it. A higher CRR reduces credit creation.
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