Question 14

Government deficit increases demand in the loanable funds market, raising the real interest rate.

A government deficit leads to higher demand for loanable funds, which in turn drives up the real interest rate as the government borrows more to finance its deficit.

A) ↑

This option is correct because it reflects the impact of a government deficit on the demand for loanable funds. When the government runs a deficit, it needs to borrow money, thus increasing the overall demand for funds in the market, which raises the real interest rate.

B) ↓

This option is incorrect as it does not accurately represent the relationship between government deficits and the loanable funds market. A government deficit will not cause a decrease in demand; instead, it causes an increase, which contradicts the implication of this choice.

C) no change

This option is also incorrect. The assertion that there would be no change in the loanable funds market is misleading, as government deficits typically lead to increased borrowing, thereby affecting both the demand and the real interest rate.

D) depends on Fed

While the actions of the Federal Reserve can influence interest rates, this option is incorrect in the context of a government deficit. The relationship between a government deficit and demand in the loanable funds market is direct and does not solely depend on the Fed’s actions.

Conclusion

The correct answer is A, as it accurately describes how a government deficit increases the demand for loanable funds, which ultimately raises the real interest rate. All other options fail to capture the direct impact of government borrowing on the loanable funds market, either denying the change or misattributing it to external factors.