If the government issues new government bonds to finance a budget deficit,the real interest rate in financial markets will ________ and investment spending will ________.

Question

Quizplus · Accepted Answer

When the government issues new bonds, it increases the supply of bonds in the market which in turn increases the competition among investors to buy these bonds. Due to this increase in supply and competition, the bond prices will decrease and as a result, the interest rates will increase. As the interest rates increase, the cost of borrowing also increases which makes businesses and firms more hesitant to invest or increase their investment. Hence, investment spending will decrease.

If the Government Issues New Government Bonds to Finance a Budget