Discuss how government borrowing to finance fiscal deficits can have a negative impact on 1. Domestic...
Discuss how government borrowing to finance fiscal deficits can have a negative impact on
1. Domestic interest rate
2. Domestic investment
3. Inflation
4. The value of the country's currency in relation to the USA dollar ( My home country is XCD)
Homework Answers
When government runs a fiscal deficit, it attempts to raise finance for it by borrowing in loanable funds market. The demand curve shifts right as demand is increased. Shortage of funds at the existing rate of interest puts an upward pressure and so domestic interest rate rises. This might decline domestic investment as private investmennt is crowded out.
Inflation rate is increased as government spending is greater than reduction in private investment. With higher interest rate, net capital outflows reduce and this appreciates the currency as it is highly demanded, Hence the currency appreciates against dollar.
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