If the U.S. government runs a budget deficit that will reduce interest rates? True False

If the U.S. government runs a budget deficit that will reduce interest rates?

True

False

Solutions

Expert Solution

TRUE

A budget deficit is when spending exceeds income. In case of US governmen, Government bonds finance the deficit. Most creditors think that the government has the highest probability to repay its creditors and hence invest more in government bonds compared to riskier corporate bonds. As a result, government interest rates remain relatively low. That allows governments to keep running deficits for years.

Long-term interest rates in the United States have been on the decline for decades now. The reasons behind the decline are

When the global investors demanding much more government debt than the federal government is supplying as in the case of US, long-term interest rates will decline . If growth in demand for something outstrips the growth of supply, then the price is going to increase. And since the price of a bond and its yield (the amount of interest paid out by a bond divided by its face value) are inversely related, interest rates are going to go down. This means that the United States government can now borrow money from the rest of the world at a very low price.

Rahul Sunny answered 1 year ago

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