Assume there is an increase in government spending ﬁnanced by government borrowing. With a speciﬁc money supply, the consequent
A) contractionary impact might be lessened by the resulting increase in the interest rate.
B) expansionary impact might be lessened by the resulting increase in the interest rate.
C) contractionary impact might be enhanced by the resulting decline in the interest rate.
D) expansionary impact might be enhanced by the resulting decline in the interest rate.

Question

Quizplus · Accepted Answer

An increase in government spending financed by government borrowing leads to an increase in aggregate demand, which can lead to inflationary pressures. However, this increase in demand may also lead to an increase in interest rates, as borrowing increases and lenders demand higher rates of return. Higher interest rates, in turn, can reduce borrowing and investment and slow down aggregate demand growth. So, the expansionary impact might be lessened by the resulting increase in the interest rate.

Assume There Is an Increase in Government Spending ﬁNanced by Government