When the U.S. government runs a deficit, the resulting higher interest rate:
A) reduces firms' desire to invest, and "crowds out" domestic investment.
B) increases firms' desire to invest, but "crowds out" domestic investment.
C) reduces foreigners' willingness to invest in the U.S., but still "crowds out" domestic investment.
D) increases foreigners' willingness to invest in the U.S., which "crowds out" domestic investment.

Question

Quizplus · Accepted Answer

When the U.S. government runs a deficit, it has to borrow more money from the bond market which increases the demand for bonds, driving up interest rates. This, in turn, increases the cost of borrowing for firms which reduces their desire to invest as a result. The higher interest rate "crowds out" domestic investment as it becomes more expensive for firms to borrow money, causing a reduction in investment.