Question

Suppose the government budget surplus falls. Compared to the last period, this tends to cause the equilibrium (private sector) long-term real interest rate to ______ and the equilibrium (private sector) quantity of loanable funds exchanged to ______.

	a.	fall, rise
	b.	fall, fall
	c.	rise, fall
	d.	rise, rise

Answer 1

C. Rise, Fall

Explaination:-The government deficit is associated with an increase in long-term interest rates. as interest rates rise, bond prices fall. Since the government raises money to cover the deficit through the sale of bonds, higher rates raises the cost of borrowing.

The budget deficit-interest rate relationship must first come to grips with an indisputable fact: budget deficits consume real resources, and this is the more relevant public policy concern. When the government borrows from the public to finance public spending or tax cuts, the resources must come from somewhere. In mainstream theory, the resources come from the nation’s pool of saving, which pushes up interest rates for simple supply and demand reasons. As a result, the deficit “crowds out” private investment that was competing with government borrowing for the same pool of national saving. Since less investment reduces the future size of the economy, economists often describe deficits as placing a burden on future generations.