Which of the following is NOT a tool of fiscal policy ?

Correct — option (2), Interest rate.

Fiscal policy is the government's use of its budget. NCERT's Class 12 macroeconomics textbook (2026-27 reprint) describes it this way: "Through changes in its expenditure and taxes, the government attempts to increase output and income and seeks to stabilise the ups and downs in the economy."

Public expenditure, option (1), and taxation, option (4), are the two sides of that budget. Deficit financing, option (3), is the choice to spend more than the government receives and cover the gap, which NCERT says must be done by "taxation, borrowing or printing money".

The interest rate is a lever of monetary policy. Under the RBI Act, 1934, as amended in 2016, the Reserve Bank of India is entrusted with conducting monetary policy, and a six-member Monetary Policy Committee determines the policy rate.

The idea to remember: spending, taxes and deficits are fiscal policy (the government); interest rates and money supply are monetary policy (the RBI).

Why the others are wrong

• (1)
  Public expenditure — Public expenditure is a fiscal tool, so it cannot be the answer. It is one side of the budget: when the government raises its purchases of goods and services, NCERT notes, aggregate demand increases.

  Raising or cutting spending to steady the economy is what NCERT calls discretionary fiscal policy.

• (3)
  Deficit financing — Deficit financing is a fiscal tool. It means running a budget in which expenditure exceeds receipts and then financing the gap.

  NCERT lists the ways a budget deficit can be financed: taxation, borrowing or printing money. The decision to run the deficit belongs to the government's budget, even though borrowing or money creation may involve the central bank.

• (4)
  Taxation — Taxation is a fiscal tool. Taxes change the gap between income and disposable income, and so change what households can spend.

  NCERT adds that a proportional income tax acts as an automatic stabiliser: when GDP rises, disposable income rises by less, which damps swings in consumption.

Governments and central banks steer demand in the economy with different instruments.

Fiscal policy works through the government budget: expenditure, taxation, and the size of the deficit and how it is financed. Parliament approves the Union budget, which Article 112 of the Constitution calls the annual financial statement.

Monetary policy works through money and credit. NCERT lists the RBI's quantitative tools as changes in the cash reserve ratio, the bank rate and open market operations, and describes repo operations as the main tool of RBI monetary policy. Changing these rates changes the cost of borrowing across the economy.

Key facts

• NCERT: through changes in its expenditure and taxes, the government tries to raise output and income and stabilise the economy.
• Under the RBI Act, 1934 (as amended in 2016), the RBI conducts monetary policy with price stability as its primary objective, keeping growth in mind.
• Section 45ZB of the RBI Act provides for a six-member Monetary Policy Committee to determine the policy rate.
• India's inflation target is 4 per cent CPI inflation, tolerance band 2-6 per cent, retained for April 2021 to March 2026.
• NCERT lists the RBI's quantitative tools as changes in the cash reserve ratio, the bank rate and open market operations.

Common traps

• Interest also appears in the budget: interest payments on government debt are part of public expenditure. Paying interest is fiscal; setting the interest rate is monetary.
• Deficit financing sounds like banking, but deciding to spend beyond receipts is a budget decision, so it is a fiscal tool.
• Open market operations deal in government bonds, yet they are a monetary tool: NCERT explains that when the RBI buys a government bond, reserves and the money supply increase.

• practice — not a real PYQ

  Which one of the following is a tool of monetary policy?

  • (a)Taxation
  • (b)Public borrowing
  • (c)Repo rate
  • (d)Subsidies
  Answer(3) — The repo rate is set by the RBI's Monetary Policy Committee and changes the cost of borrowing. Options (1), (2) and (4) are budget decisions of the government, so they are fiscal tools.
• practice — not a real PYQ

  In India, the policy repo rate is determined by

  • (a)the Finance Commission
  • (b)the Monetary Policy Committee
  • (c)the GST Council
  • (d)NITI Aayog
  Answer(2) — Section 45ZB of the RBI Act provides for the six-member Monetary Policy Committee to determine the policy rate. Option (1) recommends how the net proceeds of taxes are distributed between the Union and the States (Article 280). Option (3) is the Goods and Services Tax Council under Article 279A. Option (4) does not set the policy rate.