Passage-2
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.
Q3. Which of the following statements best reflects/reflect the most logical and rational inference/inferences that can be made from the passage?
- Central banks cannot bring down inflation without budgetary backing.
- 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
Answer: C. Both 1 and 2
Explanation:
- Statement 1 is correct: The passage implies that central banks need budgetary support to effectively combat inflation. Without fiscal discipline, governments may end up borrowing more to cover rising debt-service costs, which could counteract the effects of monetary policy. This supports the validity of Statement 1.
- Statement 2 is correct: The passage states that higher interest rates impact budget deficits and that monetary policy effectiveness depends on the fiscal policies adopted by the government. This indicates that monetary policy’s effects are indeed influenced by government fiscal actions, making Statement 2 valid.
Q4. Based on the above passage, the following assumptions have been made:
- Fiscal policies of governments are solely responsible for higher prices.
- 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
Answer: D. Neither 1 nor 2
Explanation:
- Assumption 1 is not valid: The passage does not suggest that fiscal policies alone are responsible for higher prices. It explains that inflation and interest rates are affected by both fiscal and monetary policies, meaning that other factors also contribute to higher prices. Therefore, this assumption is not supported.
- Assumption 2 is not valid: The passage does not mention the impact of higher prices on long-term government bonds. Since there is no information provided about the effect of inflation on these bonds, this assumption cannot be inferred from the passage.
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