Question

Given below is a pair of events I and II. You have to decide their nature of relationship. Assume that the given information is correct and final.

I. Inflation rate in India has come down
II. Reserve Bank of India has increased interest rate.

• A. I is the main cause and II is the main effect
• B. I is effect but II is not the main cause
• C. II is the main cause and I is the main effect
• D. II is an effect but I is not the main cause

Hint:

Ask why a central bank raises interest rates in the first place. The reason for the action tells you which event is the effect.

Answer 1

The Correct Option is C

Approach this through the purpose of the action. A central bank does not move its policy rate at random. It raises the rate with one aim in mind, which is to squeeze excess demand and bring prices under control. Once you know why an action is taken, its effect becomes obvious, and the causal arrow points from the action to the intended outcome.

1. I is the main cause and II is the main effect: This says falling inflation made the RBI raise rates. That inverts the purpose of a rate hike. When inflation is already easing, a central bank has no reason to tighten further, and would more likely leave rates alone or lower them to support growth.
2. I is effect but II is not the main cause: The first half is fine, since a fall in inflation is indeed an outcome. The second half throws away the only stated explanation. A rate hike raises the cost of credit across the whole economy, and that is precisely the lever used to slow price rise. Rejecting it as the main cause leaves the fall in inflation unexplained for no reason.
3. II is the main cause and I is the main effect: Trace the chain. Higher policy rate leads to costlier bank loans. Costlier loans lead to less borrowing by families and businesses. Less borrowing leads to weaker spending and weaker demand. Weaker demand takes the pressure off prices, and the inflation rate falls. Every link here is a standard piece of monetary economics, so this is the sound reading.
4. II is an effect but I is not the main cause: An RBI rate decision is a deliberate policy step taken by the Monetary Policy Committee. Calling it an "effect" of a price statistic reverses the role of the regulator and the market.

The correct option is (C). The interest rate hike is the tool, the drop in inflation is the result the tool was meant to produce.

Let's summarize:

• A rate hike is a tightening measure aimed at cooling demand and prices.
• Between a regulator's action and an economic outcome, the action is the cause.
• Ask what the action was meant to achieve, and the effect names itself.

So the answer is option (C): the RBI's rate hike caused inflation to come down.