If an increase in government spending causes an increase in government borrowing, this could induce
A) an increase in interest rates, which would cause private domestic investment to fall.
B) an increase in interest rates, which would cause private domestic investment to rise.
C) an increase in interest rates but no effect on private domestic investment.
D) a decrease in interest rates, which would cause private domestic investment to rise.

Question

Quizplus · Accepted Answer

An increase in government borrowing will increase the demand for loanable funds, leading to an increase in interest rates. Higher interest rates will make borrowing more expensive for firms and households, reducing their investment and consumption spending. Thus, private domestic investment is likely to fall in response to higher interest rates induced by an increase in government borrowing.

If an Increase in Government Spending Causes an Increase in Government