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

Which one of the following is likely to be the most inflationary in its effects?
  1. Repayment of public debt
  2. Borrowing from the public to finance a budget deficit
  3. Borrowing from the banks to finance a budget deficit
  4. Creation of new money to finance a budget deficit

Solution

Creation of new money (deficit financing through printing money/monetisation) to finance a budget deficit directly increases money supply without a corresponding increase in goods/services, leading to the highest inflationary impact.

Asked in: UPSC Prelims 2021

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