Question

Which of the following is true of federal deficit?

1) Other things held constant, the larger the federal deficit, the lower the level of government expenses
2) Other things held constant, the larger the federal deficit, the higher the level of the national income
3) Other things held constant, the larger the federal deficit, the more taxes the government collects
4) Other things held constant, the larger the federal deficit, the higher the level of interest rates on borrowings

Answer 1

The correct statement about the federal deficit is that it can lead to higher interest rates on borrowings due to increased government demand for credit. A larger deficit doesn't necessarily mean higher national income or more taxes collected.

Step-by-step explanation:

Among the given statements regarding a federal deficit, the true statement is that other things held constant, the larger the federal deficit, the higher the level of interest rates on borrowings. This occurs because as the demand for credit increases to fund the deficit, interest rates rise to equilibrate the demand and supply of the credit market. Increased borrowing by the government can lead to 'crowding out' where the government borrowing absorbs the available credit in the market, making less available for private borrowers and potentially raising interest rates.

A larger federal deficit does not necessarily mean that the government is spending less; in fact, it might be spending more but collecting less in taxes. Hence, the first option is incorrect. A larger federal deficit does not guarantee higher national income, and it does not imply that more taxes are being collected—those options are also incorrect.