Question

Why home(foreign) countries increase government spending can increase the world rate of interest? Provide a Keynesian story for why. What are assumptions in your conclusion?

Answer 1

Increase of government spending have direct impact on interest rate.when government spending is increases then it means fiscal deficit is also increases .it means burden of loan is increases .basically when deficit is increases then it means these deficit can be financed through sale of government bond or creation of monetary base.As we know when government sold its bond then supply is increases hence price is reduced.but interest will be increase because we have to pay interest on face value of bonds.

When government spend lot of money then it means government funds is reduces hence when funds is decreases government have to take more funds from other source and in that case interest is always increases.hence lower the price they get higher their interest bill.

As per keynesian theory government must have to increase demand for boosting of growth.as per his view government spending is one of the factor for deciding aggregate demand.as per his view higher the spending higher the demand.

i assumed that government has taken loan for spending and in that case deficit will be goes up .when deficit increases then interest rate also increases.