Question

If the government deficit increases but the interest rate remains unchanged, what might have simultaneously occurred to maintain the interest rates?

a) consumers decide to decrease consumption and work more.
b) A decrease in private sector borrowing
c) A surplus in the trade balance
d) Central bank intervention to stabilize interest rates

Answer 1

Unchanged interest rates despite increased government deficits could be explained by a decrease in private sector borrowing, increased supply of funds from consumers, a trade balance surplus, or central bank interventions to stabilize the rates.

Step-by-step explanation:

The question asks about what might keep interest rates unchanged despite an increase in government deficit. One possible explanation is decreased private sector borrowing, which could balance out the increase in demand for funds from the government. Another could be an increase in the supply of funds due to consumers working more and consuming less, thus saving more. A surplus in the trade balance could also result in increased capital inflows, keeping interest rates stable. Lastly, central bank intervention is a common method used to maintain interest rates despite fiscal changes. The central bank might conduct open market operations, buying or selling government securities to manage the money supply and hence interest rates. This intervention can prevent the changes in government borrowing and investment from affecting interest rates as depicted in supply and demand graphs for financial capital.