Question 83 from UPSC CSE 2014 - Economy

Question

If the interest rate is decreased in an economy, it will

IASCODEX · Accepted Answer

Correct Option: C. increase the investment expenditure in the economy

Strategy: The strategy is to identify the core economic relationship between lower interest rates and investment, then eliminate incorrect options through logical deduction.

- Lower rates increase, not decrease, consumption, eliminating the option suggesting decreased consumption.
- Tax collection is not directly influenced by interest rates, eliminating the option linking them.
- Lower rates typically reduce savings by making them less attractive, eliminating the option suggesting increased savings.
- This leaves only the option connecting lower rates to higher investment expenditure as the correct answer.

Key Info: Interest rates, as determined by a nation's central bank (RBI in India), have a pivotal role in influencing the economy's aggregate demand. When interest rates fall:

- **Borrowing costs decrease**, making it cheaper for firms to finance expansion plans (capital investments, plant and machinery, infrastructure). As loan repayments are lower, investment expenditure in the economy rises.

- **Savings are discouraged**, as lower deposit rates reduce returns from bank deposits, often causing households to prefer spending or investing elsewhere.

- **Consumption generally increases** because consumers find loans (for homes, cars, appliances, etc.) more affordable, and the opportunity cost of spending rather than saving diminishes.

- **Tax collection is not directly affected** by interest rate changes. It is related more to the overall level of economic activity and tax policy.

These relationships are fundamental to how monetary policy is used to stimulate or dampen economic growth. Classical and Keynesian economics both recognize the positive linkage between lower interest rates and higher investment, which multiplies through the economy.

IASCODEX · Answer

Option A: decrease the consumption expenditure in the economy

IASCODEX · Answer

Option B: increase the tax collection of the Government

IASCODEX · Answer

Option D: increase the total savings in the economy