Final answer:
An increase in the federal budget deficit causes national saving to (c) decrease and the equilibrium interest rate to increase in a closed economy because increased government borrowing raises demand for financial capital without a corresponding increase in the supply.
Step-by-step explanation:
In a closed economy, the federal government's increase in the budget deficit results in a decline in national saving and an increase in the equilibrium interest rate. Because of the growing deficit, the government is borrowing more money, which raises the need for financial capital overall.
With domestic investment and private savings remaining unchanged, the supply of loanable funds does not increase to match this demand. Consequently, the price of borrowing—interest rates—goes up. This is because, according to the national saving and investment identity, there's a relationship between savings, investment, and the budget deficit in a closed economy. In the case of an increased budget deficit, national savings get reduced because public savings are part of national savings; thus, less money is available for private investment.
As the demand for financial capital increases due to government borrowing, the supply of capital is unchanged, so the interest rate, the price of financial capital, increases to balance the demand. Looking at historical examples, such as the U.S. economy in the mid-1980s, a significant increase in the federal budget deficit led to a higher demand for financial capital, which was supplied by foreign investors, leading to a higher equilibrium interest rate and crowding out of private investment.