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#23 An expansion in government spending, unaccompanied by an increase in government revenue, results in which...

#23

An expansion in government spending, unaccompanied by an increase in government revenue, results in which of the following:

a. A decrease interest rate

b. A decrease in net capital outflows

c. An increase in the quantity of tradable loanable funds

d. None of the above

Answer is B, but why? Please explain. What concepts do I need to know to be able to get to this answer?

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Answer #1

Option (B).

Increase in government spending will increase budget deficit, to finance which, government will increase its borrowing. Higher government borrowing will increase interest rate. When interest rate increases, domestic investors save more in home country, so capital outflow decreases. Also, global investors find investment more attractive in domestic market, so capital inflow increases. As a result, net capital outflow (= capital outflow - capital inflow) decreases.

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