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Question
Read the passage given below and answer the questions that follow.
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In India, Fixed deposits have long been a favourite investment choice of people, especially senior citizens, as it promise steady returns. It attracts those who are seeking a stable income. But it’s an illusion in the period of inflation. Inflation is the rate at which the general level of prices for goods and services rises, subsequently eroding the purchasing power of money. In simple terms, what money could buy today might not a few years down the line. Fixed deposits are financial instruments offered by banks where you deposit a lump sum amount for a fixed period at a predetermined rate of interest. Consider an investment of Rs 1 crore in a fixed deposit at a 6% annual interest rate and the annual rate of inflation is 5%. By the 10th year your pre inflation return is 1.79 crore, but post inflation it’s just 1.10 crore. The nominal value of investment in fixed deposits may appear to grow, inflation significantly diminishes their real value and purchasing power over time.
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- What is the theme of the extract? (2)
- Differentiate between Demand pull and Cost push inflation. (2)
- What are the demand deposits and time deposits? (2)
- Since 1998 RBI has been using new measures of money supply, M0, M1, M2 and M3. Which one of these measures incorporates fixed deposit as one of its components? Mention the other components of that measure. (2)
Solution
- The theme of the extract is that fixed deposits are a myth during times of inflation. As inflation is a continuous rise in the price level of the economy, it causes a decline in the purchasing power of money and hence the real value of the return from the fixed deposit.
- Demand-pull inflation originates from demand forces, i.e., when aggregate demand rises and exceeds aggregate supply of goods and services, it will lead to rise in price level in the economy. Cost push inflation refers to the continuous increase in price level due to increase in cost of production caused by increase in wage rate, profit margin, etc.
- Demand deposits are deposits in a bank account where the deposited money can be withdrawn by cheques at any time. Current account deposits and savings account deposits are the demand deposits. Time deposits are deposits in a bank account where the deposited money cannot be withdrawn before the time of its maturity. Cheque is not issued on this deposit. Fixed deposits and recurring deposits are the time deposits.
- M3 incorporates a fixed deposit. Other components are currency held by the public (C), demand deposits with commercial banks (DD) and other deposits with the RBI (OD).
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