Association of Chartered Certified Accountants (ACCA) Certification Practice Test

One of the primary reasons for excess money supply leading to inflation is:

1. Increased savings rates

2. High government borrowing

3. Slow economic growth

4. Reduced foreign investment

The correct answer is: High government borrowing

High government borrowing can lead to an excess money supply in the economy, which is one of the primary reasons for inflation. When a government borrows heavily, it often leads to an increase in the money supply as the central bank may facilitate this borrowing by creating more money. This increase in money supply, without a corresponding increase in the production of goods and services, can lead to inflation because too much money chases too few goods. As people and businesses expect inflation due to an increased money supply, they may raise prices accordingly, further fueling inflationary pressures. In contrast, increased savings rates typically mean that less money is circulating in the economy, which would not lead to inflation. Slow economic growth suggests stagnant demand and usually doesn't result in inflation, as there isn't enough consumer spending to push prices higher. Finally, reduced foreign investment may lead to less capital inflow into the economy, potentially having a negative impact on growth rather than contributing to inflation.