How does reducing government spending increase the money supply? According to the following question, it seems as though cutting back on government spending increases the money supply (the answer is C).



The only possible explanation I can think of is that in the second fiscal year, the government continues to spend, but this time it spends less while not changing tax revenue ("In the absence of offsetting factors"), hence the MS still grows but the following fiscal year's deficit has reduced.
The government cuts public spending but continues to "run a deficit by borrowing from the central bank."
This is the polite way to say "increase yearly the money supply by an amount equal to the government's deficit".  

So the money supply will also increase in the second year, albeit by a smaller amount than before. But increase it will.