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Figure: The Market for Loanable Funds III
-(Figure: The Market for Loanable Funds III) Look at the figure The Market for Loanable Funds III. If the government in a closed economy is running a budget balance of zero when it decides to increase defense spending by $200 billion and then finances the spending by selling bonds, the equilibrium interest rate will:

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Use the following to answer questions :
Figure: The Market for Loanable Funds III 
-(Figure: The Market for Loanable Funds III) Look at the figure The Market for Loanable Funds III. If the government in a closed economy is running a budget balance of zero when it decides to increase defense spending by $200 billion and then finances the spending by selling bonds, the equilibrium interest rate will:

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When the government finances the $200 billion spending through selling bonds, the supply of loanable funds in the market decreases, leading to an increase in the equilibrium interest rate. The figure shows that the initial equilibrium interest rate is 15%. Since the increase in demand for loanable funds is large, it shifts the demand curve to the right from D1 to D2. The new equilibrium point is where D2 intersects with the supply curve S, which is approximately at 18% interest rate. Therefore, the correct answer is (C) rise to 18%.

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