As inflation rises, even governments previously committed to budget discipline are spending freely to help households. Higher interest rates announced by central banks are supposed to help produce modest fiscal austerity, because to maintain stable debts while paying more to borrow, governments must cut spending or raise taxes. Without the fiscal backup, monetary policy eventually loses traction. Higher interest rates become inflationary, not disinflationary, because they simply lead governments to borrow more to pay rising debt-service costs. The risk of monetary unmooring is greater when public debt rises, because interest rates become more important to budget deficits.

Which of the following statements best reflects/reflect the most logical and rational inference/inferences that can be made from the passage?
1. Central banks cannot bring down inflation without budgetary backing.
2. The effects of monetary policy depend on the fiscal policies pursued by the government.

Question

As inflation rises, even governments previously committed to budget discipline are spending freely to help households. Higher interest rates announced by central banks are supposed to help produce modest fiscal austerity, because to maintain stable debts while paying more to borrow, governments must cut spending or raise taxes. Without the fiscal backup, monetary policy eventually loses traction. Higher interest rates become inflationary, not disinflationary, because they simply lead governments to borrow more to pay rising debt-service costs. The risk of monetary unmooring is greater when public debt rises, because interest rates become more important to budget deficits.

Which of the following statements best reflects/reflect the most logical and rational inference/inferences that can be made from the passage?
1. Central banks cannot bring down inflation without budgetary backing.
2. The effects of monetary policy depend on the fiscal policies pursued by the government.

Accepted Answer

Correct Option: (c) Both 1 and 2 The passage states that 'Without the fiscal backup, monetary policy eventually loses traction.' This directly implies that central banks cannot successfully bring down inflation (monetary policy) without budgetary backing (fiscal support) from the government, making Statement 1 a valid inference. Additionally, the passage mentions that higher interest rates (monetary policy) can become inflationary rather than disinflationary if governments borrow more to service debt, showing that the real-world effects of central bank interest rate policies depend heavily on the government's fiscal choices. This makes Statement 2 a highly logical and rational inference. Since both Statements 1 and 2 are well-supported, the correct option is (c).

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