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Which of the following methods of financing economic development can lead to inflation?


1. Internal and External Borrowings
2. Progressive Taxation
3. Deficit Financing
4. Government Bonds
5.

1 Answer

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Best answer
Correct Answer - Option 3 : Deficit Financing

The correct answer is Deficit Financing.

  •  Inflation:
    • It is a continuous or persistent increase in the general price level of goods and services in the economy.
    • It reflects a reduction in the purchasing power of money.
    • Inflation will always reduce the value of money unless interest rates are higher than inflation.
    • Inflation provides benefits to debtors and loss to creditors, Debentures, bond-holders.
    • In India, Inflation is measured by Consumer Price Index and Wholesale Price Index.
    • Retail or General Headline Inflation is measured by Consumer Price Index.
    • Wholesale Inflation is measured by the Wholesale Price Index.
    • Core Inflation is General headline inflation minus food and energy (fuel) items, which are frequently subject to volatile prices.
  • Deficit Financing:
    • When there is a shortfall in the government money resources then the government will either print new currency or issue debts to finance the deficit. 
    • When the government issues bonds this can be purchased by public or central banks.
    • The government prints new currency to finance the deficit this doesn't involve any growth in economic activity hence it increases inflation. Hence, option 3 is correct. 

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