Q. With reference to Indian economy, demand-pull inflation can be caused/increased by which of the following?

1. Expansionary policies
2. Fiscal stimulus
3. Inflation-indexing wages
4. Higher purchasing power
5. Rising interest rates

Select the correct answer using the code given below. (UPSC Prelims 2021)
Answer: 1, 2 and 4 only
Notes: The correct answer is [A] 1, 2 and 4 only. Demand-pull inflation occurs when the aggregate demand for goods and services exceeds aggregate supply, essentially "pulling" prices upward due to excessive money chasing too few goods.

• Expansionary Policies (Statement 1 – Correct): These include actions by the central bank (like cutting repo rates) to increase money supply. Higher liquidity in the system encourages borrowing and spending, leading to higher demand.
• Fiscal Stimulus (Statement 2 – Correct): When the government increases public spending or reduces taxes, it puts more money into the hands of consumers and businesses, directly boosting aggregate demand.
• Higher Purchasing Power (Statement 4 – Correct): An increase in disposable income or lower unemployment levels leads to consumers having more capacity to buy products, which drives up prices when supply cannot keep pace.
• Inflation-indexing Wages (Statement 3 – Incorrect): This is generally considered a factor in Cost-Push inflation. While it provides consumers with more money, it is a reaction to existing inflation to maintain real income. It increases the cost of production for firms (wages), leading to a price-wage spiral.
• Rising Interest Rates (Statement 5 – Incorrect): This is a contractionary measure used to control inflation. Higher interest rates make borrowing expensive and encourage saving, which reduces consumption and investment, thereby lowering demand.

Historically, India has faced demand-pull inflation during periods of high credit growth and significant fiscal deficits.