In a closed economy, when the government runs a budget deficit, national saving is reduced, interest rates rise, and investment falls, holding all else constant.

Question

Quizplus · Accepted Answer

When the government runs a budget deficit, it must borrow money by selling bonds, which reduces national saving (since the money that people use to buy the bonds could have been saved instead). The increased demand for borrowing also causes interest rates to rise, and higher interest rates make investment more expensive, leading to a reduction in investment, all else equal.

In a Closed Economy, When the Government Runs a Budget