Other factors being constant, what happens when the federal government finances a growing budget deficit by increasing the amount it borrows from the private sector?
A) There will be an increase in the interest rate.
B) There will be a decrease in the interest rate.
C) The crowding out effect will be cancelled out.
D) There will be an increase in net exports.

Question

Quizplus · Accepted Answer

When the federal government borrows more from the private sector to finance a growing budget deficit, it increases the demand for loanable funds and puts upward pressure on interest rates. This is because the supply of loanable funds is limited, and when the government borrows more, it leaves less funds available for private investment. Hence, option A is the correct choice. Option C is incorrect as the crowding out effect remains even when the government borrows more from the private sector. Option D is also incorrect as an increase in net exports is not directly related to the government borrowing more from the private sector.

Other Factors Being Constant, What Happens When the Federal Government