English Language Reading Comprehension Practice – Set 41

Mentor for Bank Exams
English Language Reading Comprehension Practice – Set 41
Directions (1 – 10): Study the following passage carefully and answer the questions given beside.
Targeting the exchange rate is a monetary policy regime with a long history. It can take the form of fixing the value of the domestic currency to a commodity such as gold, the key feature of the gold standard. More recently, fixed exchange-rate regimes have involved fixing the value of the domestic currency to that of a large, low-inflation country. As another alternative, instead of fixing the value of the currency to that of the low-inflation anchor country, which implies that the inflation rate will eventually gravitate to that of the anchor country, some countries adopt a crawling target or peg in which its currency is allowed to depreciate at a  steady rate so that its inflation can be higher than that of the anchor country.
Exchange-rate targeting has several advantages. First, the nominal anchor of an exchange rate target fixes the inflation rate for Internationally traded goods, and thus directly contributes to keeping inflation under control. Second, if the exchange-rate target is credible, it anchors inflation expectations to the inflation rate in the anchor country to whose currency it is pegged. Third, an exchange-rate target provides an automatic rule for the conduct of monetary policy that avoids the time-inconsistency problem. It forces a tightening of monetary policy when there is a tendency for the domestic currency to depreciate or a loosening of policy when there is a tendency for the domestic currency to appreciate. Monetary policy no longer has the discretion that can result in the pursuit of expansionary policy to obtain employment gains which lead to time-inconsistency. Fourth,an exchange-rate target has the advantage of simplicity and clarity, which make it easily understood by the public. A "sound currency" is an easy-to-understand rallying cry for monetary policy. This has been important in France, for example, where an appeal to the "Franc fort" is often used to justify tight monetary policy.
Given its advantages, it is not surprising that exchange-rate targeting has been used successfully to control inflation in Industrialized countries. Both France and the United Kingdom, for example, successfully used exchange-rate targeting to lower inflation by tying the value of their currencies to the German Mark. In 1987, when France first pegged their exchange rate to the Mark, its inflation rate was 3%, two percentage points above the German inflation rate. By 1992 its inflation rate had fallen to 2%, a level that can be argued is consistent with price stability, and was even below that in Germany. By 1996, the French and German inflation rates had converged, to a number slightly below 2%. Similarly, after pegging to the German Mark in 1990, the United Kingdom was able to lower its inflation rate from 10% to 3% by 1992, when it was forced to abandon the Exchange Rate Mechanism (ERM). 
Exchange-rate targeting has also been an effective means of reducing inflation quickly in emerging market countries. An important recent example has been Argentina, which in 1990 established a currency board arrangement, requiring the central bank to exchange U.S. dollars for new Pesos at a fixed exchange rate of 1 to 1. The currency board is an especially strong and transparent commitment to an exchange-rate target because it requires that the note-issuing authority, whether the central bank or the government, stands ready to  exchange the domestic currency for foreign currency at the specified fixed exchange rate whenever the public requests it. In order to credibly meet these requests, a currency board typically has more than 100% foreign reserves backing the domestic currency and allows the monetary authorities absolutely no discretion. The early years of Argentina's currency board looked stunningly successful. Inflation which had been running at over a one-thousand percent annual rate in 1989 and 1990 fell to under 5% by the end of 1994, and economic growth was rapid, averaging almost 8% at an annual rate from 1991 to 1994.
1. As per the passage, which is/are true with reference to the Currency Board Arrangement ?
I. A country that introduces a currency board commits itself to converting its domestic currency on demand at a fixed exchange rate.
II. A currency board typically has more than 100% foreign reserves backing the domestic currency. 
III.Under a strict currency-board regime, interest rates adjust automatically and prevent governments from setting their own interest rates.
a) Only I
b) Only III
c) Only I and II
d) Only I and III
e) All the above
2. As per the passage, which of the following are advantages of exchange rate targeting?
I. It makes it easier to have a clearer idea about inflation expectations.
II.It is easy to understand for the common man.
III.It exacerbates the time-inconsistency problem.
a) Only I and III
b) Only I and II
c) Only II and III
d) All the above
e) None of the above
3. Which of the following if true, could act as a deterrent to adopting Exchage-Rate Targeting?
a) The targeting country loses the ability to use monetary policy to respond to domestic shocks that are independent of those hitting the anchor country.
b) Shocks to the anchor country are directly transmitted to the targeting country.
c) Vulnerablility to speculative attacks on the targeting nation's currecny.
d) All of the above
e) None of the above
4. Which of the following is/are true with reference to the passage?
I. Exchange rate targeting has been successful in both Industrialized nations and emerging nations.
II. Exchange rate targeting is a relatively new phenomenon, which picked up pace especially after the Second world war.
III. An exchange-rate target guarantees that the commitment to the exchange-rate based, monetary policy rule is sufficiently strong to maintain the target.
a) Only II
b) Only I
c) Only I and III
d) All the above
e) None of the above
5. As per the passage, Which of the following statements can be inferred?
a) Argentina was the first nation to adopt the currency board arrangement.
b) Exchange rate targeting is the best method for all nations- whether emerging or industrialized.
c) The aim of exchange rate targeting is to have lower inflation than that of the anchor country.
d) All of the above
e) None of the above
6. As per the passage, what are the various ways in which countries manage their exchange rates?
I. They fix the value of their domestic currency to that of a large, low-inflation country. 
II. They use the crawling band method wherein the rate is allowed to fluctuate in a band around a central value, which is adjusted periodically.
III.They adopt a crawling peg in which their currency is allowed to depreciate so that its inflation can be higher than that of the anchor country.
a) Only I
b) Only II and III
c) Only I and II
d) Only I and III
e) All the above
7. As per the passage, what does the author mean when he talks about 'sound currency'?
a) Currency that includes physical as well as digital mode of payments to promote cashless payment platforms in order to control black money and consequentially keep the economy sound.
b) Currency that includes digital currency wherein encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds and which operate independently of a central bank.
c) Currency that is stable, does not suffer from sudden appreciation or depreciation, is easily understood and ultimately contributes to stability in the economy.
d) Currency that includes coins, currency, demand deposits and time deposits with bank and other financial assets such as deposits with non-bank financial intermediaries, post office savings deposits, money market instruments etc.
e) None of the above.
8. Which of these is most similar to the word 'gravitate' highlighted in the passage?
a) cascade
b) tend
c) decline
d) rise
e) retreat
9. Which of these is most opposite to the word 'anchors' highlighted in the passage?
a) releases
b) hurt
c) fastens
d) mainstay
e) dismount
10. Which of these is most similar to the word 'discretion' highlighted in the passage?
a) attention
b) caution
c) vigilance
d) alternative
e) free will


Answers with Explanations:
1. C) Last paragraph of the passage- lines 2, 3 and 4 validate the first two statements while there is no mention of statement 3 anywhere. 

2. B) Paragraph 2 of the passage talks about the advantages of ERT. Statements 1 and 2 can be directly seen. However, statement 3 is opposite to the paragraph as ERT reduces time inconsistency while exacerbates means 'to make something worse'.

3. D) In such questions, try and look at the options from the viewpoint of the subject's disadvantages.
Here, statement 1 states that ERT leads to the target nation losing its ability to respond to shocks to its own economy. This is clearly a disadvantage and hence correct.
Similarly, Statement 2 states that by adopting ERT, shocks relevant to the anchor nation also get transmitted to the target nation.
Lastly, ERT makes the target nation vulnerable to speculative attacks on the nation is also a disadvantage and correct.

4. B) Paragraphs 3 and 4 mention ERT has worked in both types and also illustrate it with the help of examples. Hence, statement 1 is correct.
Statement 2 is opposite to the passage as Paragraph 1 states that ERT is an old method. Hence, statement 2 is incorrect.
Statement 3 is nowhere mentioned in the passage and is false.

5. E) In the passage paragraph 4, it has nowhere been mentioned that Argentina was the first nation to adopt the currency board arrangement. Hence, Statement 1 is incorrect.
Statement 2 is also incorrect as although ERT has benefited both developed and developing nations, there is no mention of it being the best method.  Also please note the use of extreme words is usully incorrect.
Statement 3 is opposite to what the passage- (check first paragraph).
Hence, none of the statements can be inferred.

6. D) '...fixed exchange-rate regimes have involved fixing the value of the domestic currency to that of a large, low-inflation country. As another alternative, instead of fixing the value of the currency to that of the low-inflation anchor country, which implies that the inflation rate will eventually gravitate  to that of the anchor country, some countries adopt a crawling target or peg in which its currency is allowed to depreciate at a  steady rate so that its inflation can be higher than that of the anchor country....'
Statements I and III can be seen in the paragraph above. However, Statement II is nowhere mentioned in the passage.

7. C) From the second paragraph, we can infer that a sound currency has qualities which include stability, no sudden swings, easy to understand, contributing to keeping inflation in check and ultimately aiding in economic growth and stability.

8. B) Here, gravitate means to be drawn towards something- In this case, towards the inflation rate of the anchor country.
Decline and retreat are opposite to the meaning and incorrect.
Rise means to ascend/ move up ans does not fit here.
Cascade and tend both are correct meanings but tend is much better suited here.

9. A) Here, anchor refers to fastening something to an object so it follows the same trajectory as the host object
Here, hurt is meaningless.
Fastens and mainstay are synonyms and thus incorrect.
Dismount and releases are opposites but releases is a better word as dismounts refers to getting off something-typically from a height. Eg: from a place, camel etc. .

10. E) Here, discretion refers to the power to select something/ having some autonomy over a situation
Here, all the words are synonyms of discretion. We need to see the context in which they can be used.
Attention and caution would not make sense in the statement.
Vigilance means to keep a watch and is meaningless here.
Alternative is a near enough match but free will is a better one.
Free will means the power/ choice to do as one pleases. This is the best fit here.