Two nations are located next to one another. In Nation A, people are very thrifty and...

Two nations are located next to one another. In Nation A, people are very thrifty and spend much less than their incomes; moreover, Nation A’s government runs a balanced budget every year. In Nation B, people spend all of their incomes, but their government runs consistent deficits. If Nation A’s puts the extra savings to Nation B, what happens to equilibrium interest rate in Nation B?

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Expert Solution

A government is said to run fiscal deficit when its revenue is less than its budget spending. In the given question, Nation B runs consistent deficits, whereas Nation A has balanced budget. Also people in Nation A don't spend all of their income, thus they must have surplus savings with them whereas people in Nation B have no savings as they spend all of their income.

Now, Nation B with needs of more funds ( due to government borrowing as well as no savings with people ) would generally have a higher equilibrium interest rate. If Nation A puts the extra savings to Nation B the equilibrium interest rate in Nation B will fall with more liquidity than before.

Rahul Sunny answered 1 year ago

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