Question

i.Should the government always be required to balance the budget? Explain why and include the pros and cons.

ii. How can the Federal government fund (finance) the budget deficit?

iii. If the Federal government decides to issue U.S. Treasury securities to fund the deficit, what will happen to the level of national debt, all other factors held constant?

iv. Assuming the Federal government and firms compete for the same savers’ dollars in the loanable funds market, what will likely happen to interest rates?

v. Given your answer under (ii and iii) above, is crowding out more or less likely to occur if the deficit is funded by Treasury securities? Explain.

Answer 1

i, No, government should not always be required to balance its budget because sometimes when the economy is in recession, government needs to adopt expansionary measures without caring about deficit because as the situation improves in the medium run, government can balance its budget. Also, some types of capital expenditure requires expenditure today but generate income in the future which adds to the revenue and help in balancing the budget. Thus, government should not always be required to balance its budget,

ii. It can fund the deficit by selling securities, taking loans from the loanable fund market which involves private investment, it can take help from the Central bank to monetize the deficit.

ii. Issuance of Treasury securities to fund the deficit will help in the reduction of national debt of the government.

iv. If the Federal government and firms compete for the same savers’ dollars in the loanable funds market,then rate of interest will increase in the loanable fund market because demand for loanable funds has increased.

v. If deficit is financed by Trasury securities, then crowding out is more likely to occur because demand for investment increases in the loanable funds market and this will increase the rate of interest.