Answer to Question #196186 in Microeconomics for Narendra

Question

Carefully discuss how an increase in the budget deficit may impact the private savings, private investment, and trade deficit. Carefully explain the process through which a larger budget will affect these macroeconomic variables.

Answer 1

Effects of increase in budget deficit on;

Private savings: Increases in budget deficits have a long-term impact on the economy because they reduce national saving (the total amount of money saved by individuals, firms, and governments) and hence the cash available for private investment in productive capital. In the long run, private domestic investment.

Private investment: If budget deficits are to be funded through borrowing, interest rates must rise in order for capital markets to rebalance. The crowding-out effect is caused by high interest rates, which reduce investment. If budget deficits help enhance economic growth, investors may feel more hopeful and decide to invest more, resulting in the crowding-in effect. Ultimately, if today's tax cuts are offset by future tax hikes, interest rates and investment may remain unchanged.

Trade deficit: A rising exchange rate makes it harder for exporters to sell their commodities overseas while making imports cheaper, resulting in a trade deficit (or a reduced trade surplus). As a result, a budget deficit can easily result in foreign financial capital inflows, a greater currency rate, and a trade imbalance.