UPSC Prelims 2014 Q61: Indian Economy – Money & Banking / Monetary Policy
If the interest rate is decreased in an economy, it will
- (a) decrease the consumption expenditure in the economy
- (b) increase the tax collection of the Government
- (c) increase the investment expenditure in the economy
- (d) increase the total savings in the economy
Answer: (c) increase the investment expenditure in the economy
Explanation
Effect of a lower interest rate
When the interest rate falls, borrowing becomes cheaper.
Firms borrow more to build factories and buy machines.
So investment expenditure rises.
| Option | Verdict | Reason |
|---|---|---|
| (a) Decrease the consumption expenditure | Incorrect | Cheaper loans raise consumption |
| (b) Increase the tax collection of the Government | Incorrect | No direct link |
| (c) Increase the investment expenditure | Correct | Lower cost of borrowing |
| (d) Increase the total savings | Incorrect | Lower returns discourage saving |
Chain of effects:
| Step | Result |
|---|---|
| Interest rate down | Loans cheaper |
| Investment and consumption up | Demand rises |
| Output and jobs up | Growth picks up |
| Risk | Inflation if demand grows too fast |
This is why the RBI cuts the repo rate to revive a slow economy.
Answer: (c) increase the investment expenditure in the economy.
Why each option is right or wrong
- (a) Incorrect. Lower rates make loans cheaper, so consumption expenditure rises.
- (b) Incorrect. Tax collection does not rise directly from a rate cut.
- (c) CORRECT. A lower interest rate increases investment expenditure.
- (d) Incorrect. Lower returns reduce the incentive to save.
Key point
Lower interest rate: cheaper borrowing, more investment and consumption, less saving; used by the RBI to boost growth.
Remember
Interest down, investment up.
Common mistakes
- Thinking lower rates raise savings.
- Forgetting that investment moves opposite to the interest rate.
- Linking a rate cut directly to tax revenue.
Exam tip
Interest is the price of borrowing. Lower price, more borrowing, more investment.
Sources
- NCERT Class XII — Introductory Macroeconomics, Ch 4 (Determination of Income and Employment)
- Reserve Bank of India — Monetary Policy transmission