Question

an increase in government spending without an increase in taxes will

a) reduce real Gross Domestic Product (GDP) while causing the price level to increase

b) increase real Gross Domestic Product (GDP) without affecting the price level

c) generate extra tax revenues to cover the extra spending

d) result in an increase in government borrowing

Answer 1

Answer (D)

This is called indirect crowding out. There is no increase in taxes against the increased spending and so the expansionary fiscal policy expenditures will be through deficit spending which will increase the interest rate and in turn make the consumption and investment fall. The interest rate will fall as the government will try to fill the deficit by government borrowing from private sector or foreign institutions.  

Hope this explanation helps. Thank you!!