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CA Foundation · Business Economics · Public Finance

The Government of India borrows Rs 50,000 crore by selling dated securities to the Reserve Bank of India, which pays for them by creating new money. Compared with borrowing the same amount from the public, the likely additional effect is:

Money supply rises and inflationary pressure increases. When the RBI subscribes to government securities by creating new money, it adds to high-powered money, which is deficit monetisation. Borrowing from the public merely transfers existing savings and does not by itself expand money supply.

  1. AA fall in the money supply, as the public's funds are withdrawn
  2. BAn increase in the money supply and greater inflationary pressureCorrect
  3. CNo change in either money supply or prices, because debt is only an accounting entry
  4. DA reduction in the government's revenue deficit

Explanation

When the central bank buys government securities with newly created money, high-powered money rises, expanding the money supply (deficit monetisation). Borrowing from the public only transfers existing funds, so it does not add to money supply. The option stating a fall in money supply describes public borrowing, and it is wrong here.

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