- A. 1 and 2 only
- B. 2 and 3 only
- C. 1 and 3 only
- D. 1, 2 and 3
Answer: B
Explanation
A central bank such as Reserve Bank of India (RBI), periodically intervenes in the debt market to influence the interest rates and rate of inflation in the economy. If RBI feels inflation is too high, it will sell government securities, and suck money out of the system. This act will push up interest rates in the economy, and business will cut back on capital expenditure financed by loans, reducing the demand for money. Hence statement 1 is not correct. Central banks also intervene periodically in foreign exchange markets. If the rupee is rapidly depreciating, RBI will sell dollars in the market. This will increase the supply of dollars and the demand for rupees, causing the rupee price of the dollar to come down. On the contrary, if the rupee is rapidly appreciating, RBI will buy dollars and inject rupees into the economy. This will increase the demand for dollars and the supply of rupees, thereby leading to an increase in the rupee price of the dollar. Hence statement 2 is correct. Interest rate movements in a foreign economy can stimulate action on the part of RBI. If interest rates in the US or the EU were to fall, FIIs (Foreign Institutional investors) will ramp up investments in India. The resultant demand for rupees will cause the rupee to appreciate. In response, RBI will buy dollars and inject rupees in to the system. Hence statement 3 is correct.