Which one of the following is likely to be the most inflationary in its effects?

Q: What is UPSC Prelims?

UPSC Prelims is a competitive examination conducted in India. This question is from the 2021 UPSC Prelims Economy paper.

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This UPSC Prelims 2021 Economy question has a easy difficulty level and is marked as an important question.

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Question

Which one of the following is likely to be the most inflationary in its effects?

Accepted Answer

Correct Answer: D — Creation of new money to finance a budget deficitStep-by-step Solution:Option D — Creation of new money to finance budget deficit: This is most inflationary. When the government directly borrows from the central bank (monetisation of deficit) or prints new currency, it increases the money supply without a corresponding increase in goods and services, leading to demand-pull inflation. This is the classic cause of hyperinflation. ✓Other options involve borrowing or repayment, which do not increase net money supply or may even reduce it.Why other options are incorrect:Option A (Repayment of public debt): Reduces money supply (withdraws liquidity) and is disinflationary.Option B (Borrowing from public): Transfers money from public to government; no net increase in money supply.Option C (Borrowing from banks): Reduces banks' lending capacity; may slightly increase money supply if banks create credit, but less inflationary than money creation.Key Concept: Deficit financing can be done through: (i) borrowing from public (non-inflationary), (ii) borrowing from banks (mildly inflationary), (iii) borrowing from RBI (monetisation — highly inflationary). The government and RBI agreed in 1994 to stop automatic monetisation (abolished ad hoc treasury bills). In 2021, the government announced a monetisation plan for the fiscal deficit but later dropped it due to inflationary concerns.

Which one of the following is likely to be the most inflationary in its effects?

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Which one of the following is likely to be the most inflationary in its effects?

Master UPSC Prelims with Our Test Series

More Questions from Inflation – Types, Causes, Measurement & Control

Frequently Asked Questions