Consider the following statements:

1. An additional spending by the Government of X is likely to have less impact on income than an additional transfer of X to households.

2. An additional spending by the Government of X is likely to have less impact on income if it is not accompanied by an expansion in money supply.

Which of the statements given above is/are correct?

The correct answer is  2 only.

Key PointsAnalysis of Statements

• Statement 1: An additional spending by the Government of X is likely to have less impact on income than an additional transfer of X to households.
  • This statement suggests that government spending is less effective in increasing income compared to direct transfers to households.
  • However, this is not necessarily true. Government spending can have a significant multiplier effect, leading to increased demand for goods and services, which in turn can boost income.
  • On the other hand, transfers to households may not always lead to increased spending, especially if households choose to save the additional income instead of spending it.
  • Hence, statement 1 is incorrect.
• Statement 2: An additional spending by the Government of X is likely to have less impact on income if it is not accompanied by an expansion in money supply.
  • This statement highlights the importance of monetary policy in enhancing the effectiveness of fiscal policy.
  • When the government increases spending, it can lead to higher demand for goods and services. However, if the money supply does not increase correspondingly, it could lead to higher interest rates, which might crowd out private investment.
  • An expansion in money supply ensures that sufficient liquidity is available in the economy to support increased spending and investment.
  • Hence, statement 2 is correct.

Additional Information

• Multiplier Effect:
  • The multiplier effect refers to the proportional amount of increase in final income that results from an injection of spending.
  • For example, if the government spends money on infrastructure projects, it creates jobs and increases income for workers, who then spend their income on other goods and services, further boosting the economy.
• Monetary Policy:
  • Monetary policy involves the management of money supply and interest rates by central banks to control inflation and stabilize the currency.
  • When the money supply is increased, it can lower interest rates, making borrowing cheaper and encouraging investment and spending.
  • This can complement fiscal policy measures such as increased government spending.
• Fiscal Policy:
  • Fiscal policy involves the use of government spending and taxation to influence the economy.
  • Government spending can directly stimulate economic activity, while tax policies can influence the disposable income of households and businesses.