When the government runs a deficit, the cost of borrowing _______, which _______ private demand for loanable funds.
A) increases; decreases
B) decreases; decreases
C) increases; increases
D) decreases; increases

Question

Quizplus · Accepted Answer

When the government runs a deficit, it means that it is spending more than it is taking in through revenue. To finance this deficit, the government must borrow money by issuing bonds. The increase in the supply of bonds on the market leads to an increase in the interest rate, which makes borrowing more expensive for everyone, including consumers and businesses. This increase in the cost of borrowing decreases private demand for loanable funds, as individuals and firms may not want to borrow as much if it is more expensive to do so. Therefore, the correct choice is A, as an increase in the cost of borrowing will lead to a decrease in private demand for loanable funds.

When the Government Runs a Deficit, the Cost of Borrowing