Homework Answers
The correct option is: Other things held constant, the larger the federal deficit, the higher the level of interest rates of borrowing.
Explanation: A deficit occurs when government spends more than it collects revenue in form of taxes.
Effects of federal budget deficits:
1. Increase in public sector debt: The government will have to borrow from private sector to reduce deficit.
2. Higher debt interest : Government will start selling bonds with high rate of interest to attract investors to meet its debt obligations. (Since, the interest rates are high, the price of bonds will be less)
3. Increases aggregate demand (AD): An increased government spending will increase demand in the economy which will further lead to inflation and higher real GDP.
A deficit increases real GDP, not national income. National income = GDP+ net factor income from abroad.
Real GDP is nominal GDP adjusted for inflation to reflect changes in real output.Nominal GDP is the market value of goods and services produced in an economy not adjusted for inflation.
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