In the context of monetary policy, the Liquidity Adjustment Facility (LAF) is used by RBI to:
A. Determine tax rates
B. Fix the fiscal deficit target
C. Provide long-term loans to industry
D. Manage short-term liquidity in the banking system
Answer: Option D
Solution (By JKSSB Mock Tests)
LAF allows banks to borrow money through repurchase agreements (repo) or park excess funds with RBI (reverse repo) to manage day-to-day liquidity mismatches.
Explanation:
In a liquidity trap, the nominal interest rate is at or near zero and further increases in the money supply are absorbed entirely as idle balances, rendering conventional monetary policy ineffective.
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