SSC Selection Post 2025 PYQ — Question 18

Correct Answer

Expansionary monetary policy

Explanation

When a central bank (like the Reserve Bank of India or the Federal Reserve) reduces interest rates, it is implementing an Expansionary Monetary Policy (also known as a cheap money policy). Lower interest rates make borrowing cheaper for commercial banks, businesses, and consumers. This encourages spending, increases investments, boosts consumer demand, and injects more liquidity into the financial system, thereby stimulating overall economic growth.

The other options are incorrect because they represent different economic mechanisms. Contractionary monetary policy is the exact opposite, where interest rates are increased to reduce the money supply and control high inflation (dearness). Fiscal stimulus refers to government actions regarding taxation and spending (like increasing public expenditure or cutting taxes) rather than central bank actions on interest rates. Quantitative easing (QE) is an unconventional monetary policy where a central bank purchases long-term securities directly from the open market to increase the money supply. This is typically deployed when standard interest rates are already near zero.

Key Points

An expansionary monetary policy is traditionally used during periods of economic slowdown, recession, or low inflation to revive economic activity. By lowering benchmark rates (such as the Repo Rate in India), the central bank signals commercial banks to lower their lending rates, making home loans, car loans, and business loans much more affordable.

Additional Facts

While expansionary policy is highly effective at boosting short-term employment and GDP growth, it carries a prominent risk. If left unchecked for too long, an excessive availability of money in the market can lead to high inflation. Central banks constantly balance this tightrope. When the economy begins to overheat due to over-stimulation, the central bank will pivot and reverse its stance toward a contractionary policy (raising interest rates) to stabilize prices and preserve purchasing power.

Important Questions and Answers

Question: Which primary policy interest rate does the Reserve Bank of India (RBI) cut or raise to implement its monetary policy stance?

Answer: The Repo Rate (the rate at which the central bank lends money to commercial banks).

Question: What happens to the value of a nation's currency in the international forex market when its central bank aggressively cuts interest rates?

Answer: The currency typically depreciates (weakens) because lower interest rates offer foreign investors lower returns on financial assets denominated in that currency.