Inflation: UPSC Previous Year Questions (Indian Economy)

Explanation

Statement 1 is correct: Inflation typically benefits debtors because it erodes the real value of money. When inflation rises, the value of the currency decreases, meaning the amount of money a debtor repays is worth less in real terms than when it was borrowed. For example, if a person took a loan of 1,00,000 and inflation rises by 10%, they can repay the loan in currency that is worth less, effectively reducing their real debt burden.

Statement 2 is incorrect: Inflation harms bondholders, especially those holding fixed-rate bonds. When inflation rises, the real return on bonds decreases because the bondholder receives a fixed interest payment. Inflation erodes the purchasing power of the bond’s future payments. For example, if a bond pays 5,000 per year and inflation increases by 5%, the real purchasing power of those 5,000 payments is effectively reduced.

Explanation

Budget Deficit refers to a situation where total expenditure exceeds the total revenue. A tool for raising money to create a budget deficit is known as deficit financing.

Option (a) is incorrect: Repaying public debt does not directly lead to inflation. The repayment involves transferring money to creditors as it doesn’t affect the overall money supply in the economy.

Option (b) is incorrect: Borrowing from the public means the government is taking funds from the private sector. While this may have some economic effects (like crowding out private investment), it doesn’t increase the money supply directly and is thus not highly inflationary. The funds are merely being re-distributed within the economy.

Option (c) is incorrect: Borrowing from banks is inflationary, but to a lesser extent than creating new money. Borrowing from banks usually involves financial institutions lending money that they have obtained from deposits. This could potentially affect the money supply, but not to the extent of creating new money, as the central bank can manage the liquidity and banking reserves.

Option (d) is correct: When a government prints new money to finance its deficit it directly increases the money supply. This can lead to excessive inflation if the increase in money supply outpaces the growth in the supply of goods and services in the economy. It is a direct cause of inflation because it adds to the overall demand without a corresponding increase in supply.