Which of the following measures should be taken when an eco- nomy is going through infla- tionary pressures ? 1. The direct taxes should be increased. 2. The interest rate should be reduced. 3. The public Spending should be increased. Select the correct answer using the codes given below—

To combat inflationary pressures, an economy requires contractionary policies to reduce aggregate demand. Statement 1 is correct because increasing direct taxes (personal and corporate) reduces disposable income and consumer spending, thereby sucking money out of the economy [2]. Statement 2 is incorrect because interest rates should be raised, not reduced, during inflation; higher rates increase borrowing costs, discouraging investment and consumption [4]. Statement 3 is incorrect because public spending should be decreased rather than increased; reducing government expenditure is a key mechanism of contractionary fiscal policy to slow down an overheating economy [1]. Increasing spending or lowering interest rates are expansionary measures typically used during recessions to stimulate growth, which would exacerbate inflation. Therefore, only the first measure is appropriate for controlling inflation.

Sources

1. [1] Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 4: Government Budgeting > Fiscal Policy can be either expansionary or contractionary. > p. 154
2. [2] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 5: Indian Tax Structure and Public Finance > Fiscal Drag > p. 117
3. [4] https://www.investopedia.com/terms/m/monetarypolicy.asp