UPSC Prelims 2021 · GS Paper I

Question 10: Economy and Social Development

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

aRepayment of public debt

bBorrowing from the public to finance a budget deficit

cBorrowing from the banks to finance a budget deficit

dCreation of new money to finance a budget deficit

AnswerUPSC’s answer is (d).

Creating new money to finance a deficit (monetising it) raises the money supply without any matching rise in output, so it is the most inflationary. Borrowing from the public only transfers existing money from savers to the government. Borrowing from banks can add to credit but is limited by banks' reserves and lending capacity. Repaying public debt is not a source of new money and adds no demand by itself. Remember: printing money to meet a deficit is the surest route to inflation.

Why each option is right or wrong

(a) Wrong: repaying debt creates no new money and is not inflationary by itself.
(b) Wrong: borrowing from the public moves existing money, so the effect on prices is small.
(c) Wrong: bank borrowing can expand credit, but less than outright money creation.
(d) Right: newly created money adds to demand without adding output.

Answer: UPSC’s key. Explanation: written by UPSC Grade, not by UPSC.

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Source: UPSC, Civil Services (Preliminary) Examination 2021, General Studies Paper I, Series A. The paper on upsc.gov.in.