Suppose that in an attempt to increase employment, the government increases spending and runs a deficit. As a result of this deficit there is an increase in interest rates. This deficit was most likely financed by:

Question

Quizplus · Accepted Answer

When the Treasury sells bonds to firms and households, it increases the supply of bonds in the market. This leads to an increase in interest rates as investors demand higher returns to compensate for the increased supply. Therefore, option D is the most likely way a deficit is financed that leads to an increase in interest rates. Option A is incorrect because an increase in marginal tax rates reduces disposable income, which tends to decrease spending and employment, and is unlikely to result in an increase in interest rates. Option B is incorrect because when the Treasury sells securities to the Federal Reserve, it increases the money supply, which tends to decrease interest rates, not increase them. Option C is incorrect because when the Federal Reserve sells securities to commercial banks, it does not directly finance the deficit.

Suppose That in an Attempt to Increase Employment, the Government