Question

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.

Answer 1

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.