UPSC Prelims 2021 question on New Money Deficit Financing

Statement by statement

Option (a) — INCORRECT: Repayment of public debt does inject money into the economy but its inflationary effect is limited.

Option (b) — INCORRECT: Borrowing from the public to finance a budget deficit will lead to a decrease in money supply in the market as money in the hands of the public is reduced.

Option (c) — INCORRECT: Borrowing from banks to finance a budget deficit reduces money available with banks for lending and thus is less inflationary than printing new money.

Option (d) — CORRECT: Creation of new money (monetisation of deficit) to finance a budget deficit has the most inflationary effect as it leads to an increase in total money supply in the market (new money is being created). Deficit financing through printing of currency is said to be inherently inflationary because it raises aggregate expenditure and hence aggregate demand. During the last fiscal year, monetisation of deficit was explored but dropped due to likely inflationary pressure.