Final answer:
The difference between total and primary budget deficits is due to interest payments. Total budget deficit includes these payments, unlike primary budget deficits. Fiscal policy's impact on government borrowing can affect aggregate demand and interest rates.
Step-by-step explanation:
The difference between total and primary budget deficits arises from interest payments. Total budget deficit includes interest payments on government debt, whereas primary budget deficit excludes interest payments and reflects only the shortfall from current year revenues minus expenditures. When budget deficits lead to increasing aggregate demand, especially during times when the economy is underperforming (below potential GDP), it can cause central banks to implement expansionary monetary policy to stimulate growth, which may lower interest rates and offset higher interest rates from government borrowing, thus reducing the 'crowding out' effect on private investment.
Understanding the dynamics between fiscal policy and interest rates is crucial. Fiscal policy can influence the amount the government needs to borrow, thereby affecting aggregate demand and potentially leading to higher interest rates. If the government incurs higher budget deficits, it will increase demand for financial capital, potentially raising interest rates if the central bank does not intervene. This relationship is exemplified in historical periods, such as the U.S. recessions in the late 20th century, where fiscal policy had to be reassessed due to its complex implications.