The government of Greece is running a large budget deficit. With no Ricardo-Barro effect, which of the following events will occur?
I. The supply curve of loanable funds will shift leftward.
II. A higher real interest rate crowds out investment.
III. Saving increases.

Question

Quizplus · Accepted Answer

With no Ricardo-Barro effect, the government's budget deficit will increase the demand for loanable funds, leading to a higher equilibrium interest rate. As a result, the supply curve of loanable funds will shift leftward (I) and a higher real interest rate will crowd out investment (II). Since the budget deficit implies that the government is consuming more than it is producing, it cannot lead to an increase in national saving, so III is incorrect.

The Government of Greece Is Running a Large Budget Deficit