Large government budget deficits result in increased borrowing by the government which leads to an increase in demand for credit. This increased demand leads to an increase in interest rates, which in turn reduces investment spending by businesses. As a result, it is likely that large government budget deficits drive up interest rates and reduce investment spending.

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In the Long Run

Question 29

Multiple Choice

In the long run,

A) large government budget deficits cause productivity to increase,thereby leading to inflation
B) large government budget deficits drive down interest rates and reduce investment spending
C) large government budget surpluses mean reductions in the money supply
D) changes in the government budget deficit have no effect on the capital stock
E) large government budget deficits drive up interest rates and reduce investment spending.

Correct Answer: