Q.Read the following text carefully : In an economy, a significant reduction in Aggregate demand raised concerns about future growth prospects of the country. This economic downturn underscores the urgent need for strategic measures to boost confidence of households and stimulate economic activities. Based on the above text and common understanding, explain the measures which the government may take to stabilise the indicated situation.

A sharp fall in aggregate demand threatens output and employment, so the government must act on both fiscal and monetary fronts to restore equilibrium.

On the fiscal side, the government can increase its own expenditure $G$ on infrastructure, health, or education—directly raising AD since $\text{AD} = C + I + G + (X - M)$. It can also cut taxes or raise transfer payments to boost household disposable income $Y_d = Y - T + \text{Tr}$, which lifts consumption $C = \bar{C} + c(Y_d)$ through the marginal propensity to consume. Subsidies to firms lower production costs and encourage private investment $I$.

On the monetary side, the central bank can reduce interest rates (via repo-rate cuts or open-market purchases of bonds), making credit cheaper. Lower $r$ stimulates investment demand and consumer durables spending. Easier credit norms and higher liquidity in the banking system further support borrowing. …

Why aggregate demand matters

Aggregate demand is the total planned expenditure in an economy—consumption by households, investment by firms, government purchases, and net exports. When it drops significantly, firms see unsold inventories pile up, so they cut production and lay off workers. Unemployment rises, incomes fall, and households grow pessimistic, cutting spending further. This vicious cycle can push the economy into recession.

The government's role is to break that cycle by injecting demand directly or by encouraging private agents to spend again. Think of it as filling the gap left by cautious households and firms.

Fiscal policy measures

The most direct tool is expansionary fiscal policy, which works through two channels.

Increasing government expenditure. The government can raise spending on infrastructure—roads, bridges, schools, hospitals. Every rupee spent becomes income for construction workers, suppliers, and contractors, who then spend part of it on consumption. This is the multiplier effect: initial spending ripples through the economy, raising income and output by more than the original injection. Public investment also builds productive capacity for the future, addressing both short-run demand and long-run growth.

Reducing taxes. Cutting personal income tax leaves households with higher disposable income, encouraging consumption. Lowering corporate tax or offering investment tax credits makes projects more profitable, spurring private investment. Indirect tax cuts (GST reductions on key goods) directly lower prices, boosting real purchasing power and demand.

Monetary policy coordination

Though the Reserve Bank of India conducts monetary policy independently, the government can coordinate or advocate for measures that complement fiscal action.

Lowering interest rates. The central bank can cut the repo rate, making borrowing cheaper for households (home loans, consumer credit) and firms (working capital, expansion). Lower rates also reduce the incentive to save, nudging households toward consumption.

Increasing money supply. Through open market operations—buying government securities—the RBI injects liquidity into the banking system, easing credit availability. Banks can lend more, supporting investment and consumption.

Credit guarantees and targeted lending. The government can launch schemes that guarantee loans to small businesses or priority sectors, reducing perceived risk and encouraging banks to lend even when confidence is low.

Restoring confidence

Economic downturns are partly psychological. If households expect prolonged stagnation, they postpone big purchases and save more, worsening the slump. The government's visible, credible commitment to stimulus—announcing a clear fiscal package, fast-tracking projects, ensuring timely payments to contractors—signals that recovery is coming. This can shift expectations, making households and firms more willing to spend and invest today.

Social safety nets also matter. Expanding unemployment benefits, rural employment guarantees (like MGNREGA), or direct cash transfers cushion the blow for vulnerable groups, maintaining a floor under consumption. These transfers have high multipliers because recipients spend most of the money immediately.

Supply-side complements …