Question map
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 the rising consumer prices via monetary policy means. Which one of the following is correct in respect of the above statements?
Explanation
The correct answer is Option 1. This is because both statements are factually accurate, and Statement-II provides the underlying logical rationale for the actions described in Statement-I.
- Statement-I is correct: Following the COVID-19 pandemic, global economies faced high inflation due to supply chain disruptions and pent-up demand. Consequently, major Central Banks (like the US Federal Reserve and the RBI) aggressively hiked interest rates to stabilize their economies.
- Statement-II is correct: It reflects the fundamental principle of monetary policy. Central Banks operate on the premise that increasing interest rates reduces liquidity, discourages excessive borrowing, and cools down demand, thereby controlling rising consumer prices (inflation).
Connection: Statement-II explains the "why" behind Statement-I. Central Banks hiked rates specifically because they assume these monetary tools are effective instruments to counteract inflationary pressures. Thus, Statement-II is the correct explanation for the actions taken in Statement-I.
PROVENANCE & STUDY PATTERN
Full viewThis is the quintessential 'Applied Macroeconomics' question. It fuses the biggest headline of the year (Global Rate Hikes) with the most basic chapter of the syllabus (Monetary Policy Theory). Strategy: Never read a financial headline without mapping it back to the static 'Why'—in this case, the transmission mechanism.
This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.
- Directly states that many central banks worldwide carried out interest rate hikes in the post-pandemic period.
- Explicitly ties the timing to the 'post-pandemic recent past,' matching the 2021–2023 period in the statement.
- Describes central banks 'accelerat[ing] interest rate hikes,' indicating widespread tightening actions.
- Notes consequences across multiple jurisdictions, implying these hikes were implemented by many banks.
- Collects multiple case studies titled 'Central bank responses to the post‑COVID period of high inflation,' covering many national banks (Australia, Canada, euro area, Japan, Sweden, Switzerland, US, Brazil).
- The breadth of listed central bank responses implies coordinated or widespread policy actions in response to post-COVID inflation.
States that governments and central banks worldwide enacted monetary stimulus measures in response to COVID‑19, indicating a prior phase of accommodation.
A student could note that an earlier global easing creates a plausible policy cycle where central banks later tighten (e.g., raise rates) as conditions normalise, and then check 2021–23 rate data by country/region.
Summarises a policy recommendation (from GFSR) that when the pandemic is under control authorities should 'gradually withdraw liquidity support.'
Withdrawing liquidity support is often implemented via raising policy rates or reversing asset purchases; a student could therefore look for announcements of rate hikes in 2021–23 as the pandemic waned.
Documents a specific COVID‑19 easing: the RBI temporarily reduced banks' Liquidity Coverage Ratio (LCR) requirements in 2020 and phased them back later.
This concrete example of regulatory easing and later restoration suggests a broader pattern (ease in 2020, normalise later) that a student can test by examining whether central banks moved from easing to tightening in 2021–23.
Records another accommodative step (increasing MSF borrowing limit and referencing MSF interest relative to the repo rate) taken in April 2020 to reduce COVID‑19 impact.
Shows central bank support measures and provides a baseline (accommodation in 2020) that a student could contrast with central bank policy statements and policy interest series for 2021–23 to detect hikes.
- Explains how repo rate changes transmit through money and capital markets to affect deposit and lending rates.
- Links changes in policy rate to aggregate demand, which is described as a key determinant of inflation.
- States that the primary objective of monetary policy is to maintain price stability (an explicit anti-inflation objective).
- Specifies an operational inflation target used by the central bank and government, implying use of policy tools to achieve it.
- Describes propagation of monetary policy impulses from financial markets to the real economy by influencing spending decisions.
- Supports the mechanism by which interest-rate changes can alter consumption and investment and thus inflationary pressures.
- [THE VERDICT]: Sitter. If you read any newspaper in 2022-23, 'Central Banks raising rates' was the dominant theme. S-II is basic NCERT logic.
- [THE CONCEPTUAL TRIGGER]: Monetary Policy Transmission Mechanism & Inflation Targeting Framework (Urjit Patel Committee recommendations).
- [THE HORIZONTAL EXPANSION]: Don't just stop at 'Hikes'. Memorize the siblings: 1) Quantitative Tightening (QT) vs QE, 2) The 'Neutral Rate of Interest' (r*), 3) The 'Sacrifice Ratio' (output loss to reduce inflation), 4) The exception: Bank of Japan's 'Yield Curve Control' (loose policy while others tightened), 5) Operation Twist.
- [THE STRATEGIC METACOGNITION]: The 'Why' Loop. When you see a global trend (S-I), ask 'What theoretical assumption drives this?' (S-II). The exam tests the link between the Event (News) and the Axiom (Book).
Central banks used targeted liquidity operations and special facilities to support markets and credit during the pandemic.
High-yield for UPSC: explains the instruments (e.g., TLTRO/LTRO, special liquidity windows) used in crisis response and helps compare easing vs tightening phases; links monetary policy to financial stability and fiscal coordination, useful for essays and GS3 questions on crisis management.
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > COVID-19-SPECIFIC MAJOR MONETARY POLICY MEASURES WORLDWIDE > p. 171
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > LONG TERM REPO OPERATIONS (LTROs) > p. 167
Regulators temporarily lowered or deferred liquidity requirements to free up bank lending capacity during COVID-19.
Important for banking regulation and macroprudential policy topics; clarifies trade-offs between resiliency and credit flow, connects Basel-III norms to domestic regulatory actions, and aids answers on regulatory responses in GS3 and optional papers.
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 8: Financial Market > LIQUIDITY COVERAGE RATIO > p. 236
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 21: Sustainable Development and Climate Change > N. Basel-III Framework on Liquidity Standards - Net Stable Funding Ratio (NSFR) > p. 613
Policy guidance emphasized withdrawing extraordinary liquidity support and rebuilding bank buffers once the pandemic receded.
Essential for understanding exit strategies of central banks and their link to interest-rate decisions, inflation control, and financial sector health; useful for analytical answers on transition from stimulus to normalization in GS3 and essays.
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 18: International Economic Institutions > Findings of the latest available October 2020 GFSR: > p. 520
Policy-rate changes propagate through money and capital markets to alter lending, deposits and spending, thereby affecting inflation.
High-yield for UPSC because questions often ask how central bank actions influence the real economy; links macro theory with policy implementation and fiscal-monetary interactions. Mastering this enables explanation of inflation dynamics, policy effects, and limits of rate changes.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > Transmission of Repo Rate into Lending Rate > p. 89
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > Transmission of Repo Rate into Lending Rate > p. 90
Central banks operate with an explicit price-stability objective and a numerical inflation target that guides policy decisions.
Crucial for answering questions on central bank mandates, policy credibility and macroeconomic goals; connects to public finance, growth trade-offs, and institutional frameworks.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.13 Monetary Policy > p. 60
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > The following are the various functions of RBI: > p. 65
Central banks use tools like repo/bank rates, reserve requirements and open-market operations to change money supply and influence inflation.
Practically important for explaining how policy is executed and limits of tools (e.g., sterilization); aids in comparing policy responses across contexts and in policy-evaluation essays.
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 3: Money and Banking > 3.4 POLICY TOOLS TO CONTROL MONEY SUPPLY > p. 42
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > The following are the major instruments/tools that RBI uses for conducting its monetary policy: > p. 64
The 'Bank of Japan' Exception. While the question says 'many' central banks raised rates, the Bank of Japan maintained ultra-loose policy (Yield Curve Control) during this exact period to fight deflation, causing the Yen to crash. This divergence is a prime candidate for a future statement.
The 'Because' Test for Explanation Questions. Read it as: 'Statement I happened BECAUSE Statement II is true.' -> 'Banks raised rates (Action) BECAUSE they assume it fixes inflation (Theory).' Does this make sense? Yes. Also, the word 'generally' in S-II is a classic safety valve, making the statement broadly true.
Link to GS3 (External Sector): Fed Rate Hikes -> Capital Flight from Emerging Markets (FPI outflow) -> Rupee Depreciation -> Imported Inflation. This creates the 'Vicious Cycle' that RBI has to manage using Forex reserves.