In the long run a budget deficit is likely to cause a decrease in GDP because:

Question

Quizplus · Accepted Answer

When a government runs a budget deficit, it usually has to borrow money by selling bonds. This increases the government's demand for loanable funds, which drives up interest rates. As interest rates rise, domestic investment decreases as borrowing becomes more expensive. This lower investment will lead to a lower capital stock, which will lead to a lower potential GDP in the long run. Hence, option B is the correct answer. Options A, C and D are not likely outcomes of a budget deficit.

In the Long Run a Budget Deficit Is Likely to Cause