Prelims 2021

Q. Which among the following steps is most likely to be taken at the time of an economic recession?

a) Cut in tax rates accompanied by increase in interest rate.
b) Increase in expenditure on public projects.
c) Increase in tax rates accompanied by reduction of interest rate.
d) Reduction of expenditure on public projects.

Correct Answer: b) Increase in expenditure on public projects.

Question from UPSC Prelims 2021 GS Paper

Explanation : 

Government Measures During Economic Recession

During an economic recession, governments and central banks typically take steps to stimulate the economy and counteract the downturn. The correct answer is “Increase in expenditure on public projects,” and here’s why this measure is likely to be taken:

1. Increase in Expenditure on Public Projects

This is a form of fiscal stimulus. By increasing spending on public projects such as infrastructure, the government can directly inject money into the economy, which can help create jobs and increase demand for services and materials. This, in turn, can help to kick-start economic growth. This approach is based on Keynesian economic theory, which advocates for increased government expenditures and lower taxes to stimulate demand and pull the economy out of a recession.

2. Cut in Tax Rates Accompanied by Increase in Interest Rate

This combination is less likely because while cutting taxes can put more money into consumers’ and businesses’ hands, increasing interest rates would have the opposite effect. Higher interest rates make borrowing more expensive, which can reduce consumption and investment, potentially deepening the recession.

3. Increase in Tax Rates Accompanied by Reduction of Interest Rate

Increasing tax rates during a recession would generally be considered counterproductive because it would reduce the amount of disposable income for consumers and businesses, potentially worsening the economic downturn. However, reducing interest rates is a common monetary policy tool used to stimulate the economy by making borrowing cheaper, encouraging investment and spending.

4. Reduction of Expenditure on Public Projects

This step is generally not taken during a recession because it would lead to a decrease in government spending, one of the components of aggregate demand. Reducing government spending could exacerbate the recession by further decreasing overall demand in the economy.

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