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

The most inflationary method of financing a budget deficit is the creation of new money.

Option A is incorrect: Repayment of public debt involves the government transferring money back to the creditors (the public). This increases the liquidity and money supply in the hands of the public. However, it is generally less inflationary than printing new money because the funds used for repayment often come from tax revenues, which reduces the disposable income of the public elsewhere.

Option B is incorrect: Borrowing from the public involves a transfer of existing money from individuals and private institutions to the government. Since the total money supply in the economy remains the same (it just changes hands), this is considered the least inflationary way to finance a deficit.

Option C is incorrect: Borrowing from commercial banks can lead to an increase in the money supply if banks use their excess reserves to lend to the government, potentially leading to credit creation. While more inflationary than borrowing from the public, its impact is still significantly lower than the direct creation of new money.

Option D is correct: Creation of new money (often called deficit financing or monetization of debt) occurs when the central bank prints new currency to fund government expenditure. This directly increases the 'high-powered money' or monetary base in the economy. This expansion of the money supply, without a corresponding increase in the production of goods and services, leads to a sharp rise in price levels, making it the most inflationary option.