Question

Rio declares financial emergency ahead of Olympics, requests federal funding Rio de Janeiro requested federal funding to help pay for public services dur- ing the Olympics, at a time when Brazil’s federal government revenue has fallen and created a large deficit.

Draw a graph of the loanable funds market in Brazil. Suppose that the Brazilian government borrows the required funds in the loanable funds mar- ket. How will this borrowing change the real interest rate and the quantity of saving in Brazil?

Answer 1

Increase in government funding for Olympics will be an additional spending which will increase budget deficit, to finance which government would resort to borrowing. Higher borrowing will increase the demand for loanable funds, shifting the demand curve rightward, thus increasing both real interest rate and quantity of loanable funds (saving and investment).

In following graph, D0 & S0 are initial demand & supply curves for loanable funds, intersecting at point A with initial real interest rate r0 & quantity of loanable funds (Savings and investment) Q0. As demand for loanable funds rises, D0 shifts right to D1, intersecting S0 at point B with higher real interest rate r1 and higher quantity of loanable funds (Savings and investment) Q1.