-Refer to the above figure. Suppose that the economy initially is operating along AD1. If the government seeks to close the recessionary gap by raising government spending without any change in taxation, which moves the aggregate demand curve from AD1 to AD2, then to AD3. Which of the following scenarios is TRUE?

Question

Quizplus · Accepted Answer

When the government increases spending without changing taxes, it typically finances the additional spending by borrowing more. This increased demand for loanable funds tends to push interest rates up. Higher interest rates, in turn, discourage private investment because borrowing costs are higher. Thus, interest rates rise and investment falls.

-Refer to the Above Figure