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

Answer: (d) Creating new money to finance a budget deficit

Creating new money to finance a deficit is the most inflationary route. It adds fresh high-powered money to the economy, raising demand with no matching cut in anyone else's spending power. Borrowing from the public only shifts existing money. Borrowing from banks can expand credit but adds no new reserve money. Repaying debt finances no deficit at all.

• ✗ (a) Repaying public debt transfers money back to bondholders. It does not finance a deficit or create new money, so its effect on prices is far weaker than monetising a deficit.
• ✗ (b) Borrowing from the public moves existing purchasing power from savers to the government. What the government spends, the public gives up, so the money supply does not rise and the inflationary push is limited.
• ✗ (c) Commercial banks can lend to the government by creating credit, so this is more inflationary than borrowing from the public. But it is limited by the banks' reserves and adds no new reserve money. It is therefore less inflationary than creating fresh money.
• ✓ (d) When the central bank funds the government's spending, new currency or reserve money is created. This is called monetisation of the deficit. Each unit of this high-powered money can support a multiple expansion of money and credit, so demand rises without a matching rise in output.

Remember · Deficit financing through new money (monetisation) is the most inflationary route. Bank borrowing comes next, and borrowing from the public only shifts existing money.

📘 Read it in NCERT: Class 12 Introductory Macroeconomics, Ch 5 (practise this chapter)

Question: UPSC Civil Services (Preliminary) 2013, General Studies Paper I. Explanation: Minimalist IAS, checked 25 Oct 2026 (how we verify). · Report an error