Final answer:
Debt deflation can start from the reduction in debt-serviceability, which is affected by various factors including higher interest rates and falling asset prices. In the financial market, a rise in the supply of loanable funds leads to a decline in interest rates, while government measures to reduce deficits can contract aggregate demand and potentially lower interest rates.
Step-by-step explanation:
Debt deflation can start from a variety of events that negatively affect the ability to service debt. Among the correct options provided, c. The reduction in debt-serviceability is a direct trigger for debt deflation since it reflects the borrowers' decreased ability to pay off their debts. This could be due to higher interest rates, income reductions, or falling asset prices, such as a stock market crash. An increase in interest rates (b. An increase in interest rates) often leads to a reduction in debt-serviceability, as it raises the cost of borrowing.
Regarding changes in the financial market that will lead to a decline in interest rates, the correct answer is c. a rise in supply of loanable funds. This increase in supply, without a corresponding increase in demand, puts downward pressure on the cost of borrowing, which is the interest rate. In contrast, an increase in demand would likely cause interest rates to rise, while a fall in supply would exacerbate this effect.
It's important to understand that the mechanisms that influence interest rates involve complex interactions between demand and supply in the financial markets. When the government takes steps to reduce budget deficits through spending cuts and tax increases, it can have a contractionary effect on aggregate demand in the economy, which could potentially decrease demand for loanable funds and lead to lower interest rates.