Which one of the following is likely to be the most inflationary in its effect?

Creating new money to finance a budget deficit, also known as deficit monetization, is the most inflationary method. When the government borrows from the central bank (RBI), it directly increases the high-powered money and the total money supply in the economy [1]. This expansion of the money supply increases the purchasing power and aggregate demand [2]. If the economy's resources are already fully utilized, this surge in demand leads to a rise in the general price level, creating an inflationary spiral [3]. In contrast, borrowing from the public (Option 2) merely transfers existing money from private hands to the government, which is less inflationary as it does not create new money. Repayment of debt (Option 1) can be contractionary if funded by taxes, and borrowing from banks (Option 3) is less potent than direct money creation because it depends on the credit multiplier and existing reserves.

Sources

1. [1] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 5: Indian Tax Structure and Public Finance > IMPLICATIONS OF FISCAL DEFICIT > p. 111
2. [2] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 5: Indian Tax Structure and Public Finance > Adverse Effects of Deficit Financing > p. 113
3. [3] Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 4: Government Budgeting > 4.8 Perspectives on Deficit and Debt > p. 158