If the government runs a budget deficit to fight a war and there is no Ricardo-Barro effect, what is an impact of the deficit?

Question

Quizplus · Accepted Answer

If there is no Ricardo-Barro effect, the deficit spending during war will increase demand for loanable funds, which will push up the real interest rate. This will make borrowing more expensive, reducing investment, and crowding out private investment. Hence, the correct answer is D) the real interest rate rises. Option A is incorrect because the quantity of private saving should increase in the short run due to increased income from government spending. Option B and E are incorrect because the increase in real interest rates makes capital more expensive, which would discourage investment. Option C is incorrect because animal spirits refers to irrational optimism about future economic prospects, which has nothing to do with the deficit per se.

If the Government Runs a Budget Deficit to Fight a War