Question

Which among the following steps is most likely to be taken at the time of an economic recession?
1. Cut in tax rates accompanied by increase in interest rate
2. Increase in expenditure on public projects
3. Increase in tax rates accompanied by reduction of interest rate
4. Reduction of expenditure on public projects

Answer 1

Correct Answer - Option 2 : Increase in expenditure on public projects

The correct answer is Increase in expenditure on public projects.

• An economic recession is typically defined as a decline in the gross domestic product (GDP) for two or more consecutive quarters. 
• High-interest rates are a cause of recession because they limit liquidity, or the amount of money available to invest. Hence statements 1 and 3 are not correct
• Inflation refers to a general rise in the prices of goods and services over a period of time. As inflation increases, the percentage of goods and services that can be purchased with the same amount of money decreases.
• An increase in public expenditure rises GDP by the same amount, other things equal.
• Moreover, since income is an important determinant of consumption, that increase in income will be followed by a rise in consumption.
• Public expenditure plays four main roles:
  • It contributes to current effective demand;
  • It expresses a coordinated impulse on the economy, which can be used for stabilization, business cycle inversion, and growth purposes;
  • It increases the public endowment of goods for everybody;
  • It gives rise to positive externalities to the economy and society as a whole (or in specific sectors and geographical areas), the more so through its capital component. Hence statement 2 is correct.