Sia
Question
Statistics
Posted 10 months ago
Which of the following would be a result of a government moving from a balanced budget to a budget deficit?
Choose 1 answer:
(A) Interest rates increase
(B) The money supply decreases
(C) Bond prices increase
(D) Government borrowing decreases
(E) Aggregate demand decreases
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Answer from Sia
Posted 10 months ago
Solution by Steps
step 1
To understand the economic impact of a government moving from a balanced budget to a budget deficit, we need to consider the basic principles of fiscal policy and its effect on the economy
step 2
A budget deficit occurs when a government's expenditures exceed its revenues. To finance this deficit, the government will need to borrow money, typically by issuing bonds
step 3
Increased government borrowing can lead to higher demand for loanable funds. According to the loanable funds theory, this can cause interest rates to rise as the supply of funds is finite
step 4
Higher interest rates can lead to a decrease in investment and consumer spending, which are components of aggregate demand. However, the immediate effect of government spending is an increase in aggregate demand
step 5
The money supply is not directly affected by government borrowing in the short term unless the central bank decides to change its monetary policy in response to the fiscal policy
step 6
Bond prices are inversely related to interest rates. If interest rates increase due to higher government borrowing, bond prices would typically decrease, not increase
step 7
Government borrowing does not decrease as a result of moving to a budget deficit; it increases because the deficit needs to be financed
step 8
Aggregate demand initially increases due to the government's additional spending, which is the direct opposite of choice E
Answer
A
Key Concept
Government borrowing and interest rates
Explanation
When a government moves from a balanced budget to a budget deficit, it increases borrowing, which can lead to higher interest rates due to the increased demand for loanable funds.
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