Q. Consider the following statements:
1. Counter-cyclical fiscal policy stabilizes the business cycle by being contractionary in good times and expansionary in bad times.
2. Pro-cyclical fiscal policy is the one wherein fiscal policy reinforces the business cycle by being expansionary during good times and contractionary during recessions.
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: C
Notes:

Indian Kings used to build palaces during famines and droughts to provide employment and improve the economic fortunes of the private sector.  

  • Economic theory, in effect, makes the same recommendation: in a recessionary year, Government must spend more than during expansionary times.  
  • Such counter-cyclical fiscal policy stabilizes the business cycle by being contractionary (reduce spending/increase taxes) in good times and expansionary (increase spending/reduce taxes) in bad times.  
  • On the other hand, a pro-cyclical fiscal policy is the one wherein fiscal policy reinforces the business cycle by being expansionary during good times and contractionary during recessions. 

Source: Economic Survey 2020 – 2021