FISCAL POLICY UPSC PRELIMS MCQS
Q. Consider the following statements: CAPF (2024)
- The 15th Finance Commission used fiscal effort as a criterion for horizontal devolution unlike the 14th Finance Commission.
- Both the 14th and the 15th Finance Commission used pre-2011 demographic variables as a criteria for horizontal devolution.
Which of the statements given above is/are correct?
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
Answer: (a) 1 only
Explanation:
Statement 1 is correct.
- The 15th Finance Commission (FC) introduced fiscal effort as a new criterion for horizontal devolution. Fiscal effort measures the tax revenue of a state relative to its Gross State Domestic Product (GSDP). The 14th FC did not use this parameter—it relied more on income distance, population, and area. Hence, this is a distinguishing feature of the 15th FC.
Statement 2 is incorrect.
- The 14th FC used the 1971 population data (pre-2011) as a demographic variable to balance incentives for states that had controlled population growth.
- The 15th FC, however, shifted to using the 2011 population data, reflecting the need to update demographic realities. It did not use pre-2011 data.
Q. Which of the following policies help to raise interest rate unambiguously and thereby lead to appreciation of currency? [CDS-I 2023]
A. Expansionary fiscal and monetary policy
B. Contractionary fiscal and monetary policy
C. Contractionary fiscal policy and expansionary monetary policy
D. Contractionary monetary policy and expansionary fiscal policy
Answer: (b) Contractionary fiscal and monetary policy
Explanation:
- A contractionary fiscal policy (reducing government spending or increasing taxes) lowers aggregate demand, reducing fiscal deficit and borrowing needs.
- A contractionary monetary policy (raising policy rates, reducing money supply) directly pushes interest rates upward.
- When both fiscal and monetary policies are contractionary, the combined effect unambiguously increases interest rates.
- Higher domestic interest rates attract foreign capital inflows, leading to currency appreciation.
- In contrast, mixed policies (expansionary vs contractionary) create ambiguity in interest rate movements.
Q. Which one of the following expenditures is subtracted from Fiscal Deficit to arrive at Primary Deficit? [CDS-II /2023]
A. Defence expenditure
B. Expenditure on subsidies
C. Interest payments
D. Pension
Answer: (c) Interest payments
Explanation:
- Fiscal Deficit = Total Expenditure – (Revenue Receipts + Non-debt Capital Receipts).
- Primary Deficit = Fiscal Deficit – Interest Payments.
- It indicates the government’s borrowing requirements excluding the burden of past debt.
- If the primary deficit is zero, it means the government is only borrowing to meet interest obligations, not to fund current expenditure.
Q. Which one of the following functions as an automatic stabilizer in the context of fiscal and monetary policies of an economy? [CAPF 2021]
A. Reverse repo rate of bank
B. Open market operation
C. Bond price
D. Personal income tax
Answer: (d) Personal income tax
Explanation:
- Automatic stabilizers are fiscal tools that work without deliberate government intervention, cushioning economic fluctuations.
- Personal income tax acts as such a stabilizer:
- In booms, rising incomes push people into higher tax brackets → government collects more tax → disposable income reduces → inflationary pressure is contained.
- In recessions, falling incomes reduce tax liability → disposable income rises → helps boost demand.
- Monetary policy tools like repo/reverse repo or open market operations are discretionary, not automatic.
Q. The excess of total expenditure of Government over its total receipts, excluding borrowings, is known as: [CDS-I 2021]
A. Primary deficit
B. Current deficit
C. Capital deficit
D. Fiscal deficit
Answer: (d) Fiscal deficit
Explanation:
- Fiscal Deficit = Total Expenditure – (Revenue Receipts + Non-debt Capital Receipts).
- It represents the borrowing needs of the government to bridge the gap between expenditure and non-borrowing receipts.
- Primary Deficit = Fiscal Deficit – Interest Payments.
- Revenue Deficit (not in options here) = Revenue Expenditure – Revenue Receipts.
- Hence, fiscal deficit shows the total resource gap that the government meets through borrowing, both internal and external.
