Passage: As inflation rises, even governments previously committed to budget discipline are spending freely…
Passage: As inflation rises, even governments previously committed to budget discipline are spending freely to help households. Higher interest rates announced by central banks are supposed to help produce modest fiscal austerity, because to maintain stable debts while paying more to borrow, governments must cut spending or raise taxes. Without the fiscal backup, monetary policy eventually loses traction. Higher interest rates become inflationary, not disinflationary, because they simply lead governments to borrow more to pay rising debt-service costs. The risk of monetary unmooring is greater when public debt rises, because interest rates become more important to budget deficits.
Which of the following statements best reflects/reflect the most logical and rational inference/inferences that can be made from the passage?
1. Central banks cannot bring down inflation without budgetary backing.
2. The effects of monetary policy depend on the fiscal policies pursued by the government.
Select the correct answer using the code given below:
1 only
2 only
Both 1 and 2
Neither 1 nor 2
Solution
Inference 1 is correct: without fiscal backing, monetary policy loses effectiveness, implying budgetary backing is crucial for central banks to control inflation. Inference 2 is correct: the passage states 'Without the fiscal backup, monetary policy eventually loses traction', clearly indicating monetary policy effectiveness depends on the government's fiscal policies. Hence both inferences are valid.