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    Question

    In the context of Inflation, consider the following

    statements: 1. Base Effect is the impact of the price levels of the previous year on the calculation of the inflation rate. 2. Decrease in the Cash Reserve Ratio can increase Inflation in the economy. Which of the statements given above is/are incorrect?
    A 1 only Correct Answer Incorrect Answer
    B 2 only Correct Answer Incorrect Answer
    C Both 1 and 2 only Correct Answer Incorrect Answer
    D Neither 1 nor 2 Correct Answer Incorrect Answer

    Solution

    Base Effect Refers to the impact of an increase in the price level (i.e. previous year's inflation) over the corresponding rise in price levels in the current year (i.e., current inflation). Cash Reserve Ratio (CRR) is the share of a bank’s total deposit that is mandated by the Reserve Bank of India (RBI) to be maintained with the latter as reserves in the form of liquid cash. When the cash reserve ratio is minimised, commercial banks will have more funds and hence, the money supply of the banking system will increase. When there is a rise in the money supply, excessive funds will result in high inflation.

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