As inflation rises, even governments previously committed to budget discipline are spending freely to help households.
Higher interest rates announced by central banks are supposed to help produce modest fiscal austerity, because to maintain stable debts while paying more to borrow, governments must cut spending or raise taxes. Without the fiscal backup, monetary policy eventually loses traction. Higher interest rates become inflationary, not disinflationary, because they simply lead governments to borrow more to pay rising debt-service costs. The risk of monetary unmooring is greater when public debt rises, because interest rates become more important to budget deficits.
Q1. Which of the following statements best reflect the most logical and rational inference/inferences that can be made from the passage?
1. Central banks cannot bring down inflation without budgetary backing.
2. The effects of monetary policy depend on the fiscal policies pursued by the government.
Select the correct answer using the code given below:
a) 1 only
b) 2 only
c) Both 1 and 2
d) Neither 1 nor 2
Correct answer: c) Both 1 and 2
Q2. Based on the above passage, the following assumptions have been made:
1. Fiscal policies of governments are solely responsible for higher prices.
2. Higher prices do not affect the long-term government bonds.
Which of the assumptions given above is/are valid?
a) 1 only
b) 2 only
c) Both 1 and 2
d) Neither 1 nor 2
Correct answer: d) Neither 1 nor 2
Question from UPSC Prelims 2024 CSAT Paper
Explanation Q1:
To answer this question, let’s analyze the passage and the given statements:
1. “Central banks cannot bring down inflation without budgetary backing.”
2. “The effects of monetary policy depend on the fiscal policies pursued by the government.”
Let’s examine the relevant parts of the passage:
– The passage states that “Without the fiscal backup, monetary policy eventually loses traction.” This suggests that fiscal policy (budgetary decisions) is important for the effectiveness of monetary policy.
– It also mentions that “Higher interest rates become inflationary, not disinflationary, because they simply lead governments to borrow more to pay rising debt-service costs.” This implies that without appropriate fiscal measures, monetary policy (like raising interest rates) can have the opposite of its intended effect.
– The passage concludes by saying, “The risk of monetary unmooring is greater when public debt rises, because interest rates become more important to budget deficits.” This further emphasizes the relationship between fiscal policy (public debt) and the effectiveness of monetary policy (interest rates).
Based on these points, we can conclude:
Statement 1 is supported by the passage. While it’s a strong statement, the passage does suggest that central banks’ efforts to control inflation can be undermined without appropriate fiscal measures.
Statement 2 is clearly supported by the passage. The entire text emphasizes how the effectiveness of monetary policy is influenced by government fiscal policies.
Therefore, the correct answer is: c) Both 1 and 2
Explanation Q2:
Let’s analyze each assumption based on the information provided in the passage:
1. “Fiscal policies of governments are solely responsible for higher prices.”
The passage doesn’t support this assumption. While it discusses the impact of fiscal policies on inflation, it doesn’t suggest that fiscal policies are the sole cause of higher prices. In fact, the passage mentions other factors:
– It starts by mentioning inflation as a given condition: “As inflation rises…”
– It discusses the role of monetary policy (interest rates set by central banks) in attempting to control inflation.
– It describes a complex interplay between fiscal and monetary policies, rather than attributing inflation solely to fiscal policies.
2. “Higher prices do not affect the long-term government bonds.”
The passage doesn’t directly address this assumption. It doesn’t mention the impact of higher prices (inflation) on long-term government bonds. Instead, it focuses on:
– The impact of higher interest rates on government borrowing costs.
– The relationship between public debt, interest rates, and budget deficits.
There’s no information in the passage to either support or refute this assumption about long-term government bonds.
Given this analysis, we can conclude:
– Assumption 1 is not valid based on the information in the passage.
– Assumption 2 cannot be evaluated as valid or invalid based on the information given.
Therefore, the correct answer is: d) Neither 1 nor 2