Question

“The Hong Kong government has announced 120 billion Hong Kong dollars ($15.4 billion) worth of measures to support an economy that’s been dragged down by pro-democracy protests and the new coronavirus outbreak. That planned spending would result in “an all-time high” fiscal deficit of 139.1 billion Hong Kong dollars for the coming financial year…”. (source: CNBC. Hong Kong plans $15 billion spending to support its economy amid coronavirus outbreak.2020/02/26)

Analyse the impact of the budget deficit mentioned above on the market of loanable funds in Hong Kong. Use graph to illustrate your answer. (20 marks)

Answer 1

To finance the reulting budget deficit, government will resort to borrowing, which is a use of (demand for) loanable funds. This will increase the demand for loanable funds, shifting demand curve rightward, increasing both interest rate and quantity of loanable funds.

In following graph, D0 and S0 are initial demand and supply curves of loanabel funds, intersecting at point A with initial interest rate r0 and quantity of loanable funds Q0. As demand rises, D0 shifts rightward to D1, intersecting S0 at point B with higher interest rate r1 and higher quantity of loanable funds Q1.