Which one of the following is likely to be the most inflationary in its effects?
Repayment of public debt
Borrowing from the public to finance a budget deficit
Borrowing from the banks to finance a budget deficit
Creation of new money to finance a budget deficit
Answer is Right!
Answer is Wrong!
This question was previously asked in
UPSC IAS – 2021
A) Repayment of public debt: This is paying back outstanding loans. It injects liquidity into the economy but is not a method of financing a *deficit*.
B) Borrowing from the public: The government borrows existing savings from individuals and institutions. This transfers purchasing power from the public to the government, using existing money. It is generally considered the least inflationary method of deficit financing.
C) Borrowing from the banks: Banks can create credit based on their reserves. When the government borrows from banks, it can lead to an expansion of credit and money supply, which is more inflationary than borrowing from the public, but less so than creating new money.
D) Creation of new money (Monetizing the deficit): This involves the central bank directly financing the government deficit, essentially printing new money or crediting the government’s account without a corresponding withdrawal of purchasing power from the economy. This directly increases the money supply and is widely considered the most inflationary method of financing a deficit, as it adds fresh liquidity without increasing the supply of goods and services in the short term.