UPSC Prelims 2021 Question:

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

Explanation:

• Creation of new money to finance a budget deficit will lead to increase in money supply in the economy without any increase in output of goods and services. This increase in liquidity will push up money multiplier resulting in multi-fold increase in money-supply in the economy. This increased money supply would lead to hyperinflation like the scenario observed in Post-WW1 Germany & in Zimbabwe.
  
  
• Repayment of public debt can be used to banks to grant loans for investments in the economy. It can also be taken out of the market through tight monetary policy of the RBI like increase in Cash Reserve Ratio, selling of government securities in the open market etc. Thus, it will not necessarily lead to inflation.
  
  
• Borrowing from the public or banks will lead to a crowding out effect. This will effectively reduce the lending by the banks to the private sector and increase the cost of borrowings. Thus, it will not necessarily lead to inflation.
  
  

Therefore, option (4) is the correct answer.

Relevance: Government retains 4% inflation target for RBI’s rate panel for 2021-26

Subject: Economics | Money and Banking