Question

How does the large U.S deficit cuase slower econmic growth, intrest rate increase, asset bubble formation, less investment, and inflation.

Answer 1

A large US budget deficit means that the tax revenue will be overshadowed by the government expenditure. This is a sign of economic weakness and so the level of GDP growth falls as the budget deficit expands. This will mean that the fiscal deficit as a percentage of the GDP will be greater. A large budget deficit will mean also that public investment will be higher. This raises the demand for money for public investment and so the interest rates rise causing borrowing to become more difficult for the private sector. Private sector borrowing will thus fall as public sector borrowing rises. As interest rates rise the value of bonds will rise and so this will increase the price of assets and so create an asset bubble beyond a point. As government investment rises because of the increased spending the private spending will get crowded out. As the budget is running into deficit the effect will be because of lower taxes and increased government spending. This will mean consumer disposable income will rise and so consumer spending will rise and this will cause rising prices. Thus inflation will rise.