Question

5. Suppose the government borrows $20 billion less next year than this year. a. Use a supply-and-demand diagram to analyze this policy. Does the interest rate rise or fall? b. What happens to investment? To private saving? To public saving? To national saving? Compare the size of the changes to the $20 billion of less government borrowing. c. Will this cause crowding - out or crowding - in effect? Please explain.

Answer 1

It is given that government is borrowing less in the coming year

a) This would imply that there will be an increase in budget surplus or a decline in budget deficit when borrowings are expected to decline. Supply curve will shift to the right in loanable funds market. As a result interest rate declines and quantity of funds increased

b) Investment rises as interest rate is reduced. Since government spending is reduced, public saving is increased. Private saving declines as reduction in government spending would reduce income and thus, both consumption and private saving. National saving however increases because fall in private saving is less than rise in public saving

c) This causes crowding in because fall in interest rate makes funds available for private investment.