The federal government seeks ways to increase the total investment component of GDP. In response to the government’s objective, economist Sean Zadora recommends that the federal government lower taxes on interest earned on savings accounts. Zadora’s colleague, Timothy Smythe, recommends that the federal government reduce its budget deficit. Regarding their statements, Zadora and Smythe are: Zadora Smythe A) Correct Correct B) Correct Incorrect C) Incorrect Incorrect The correct answer was A) Correct Correct Explanation: A reduction in the government deficit, as recommended by Smythe, indicates that the government’s negative savings is lessening, thereby contributing positively to total investment. Also, as the government reduces its deficit, it will likely lead to lower interest rates and to a smaller “crowding out effect” of private investment. ------------------------------------------------------- I’m a bit confused on the effects of a budget deficit. In my understanding, a reduction in the budget deficit will crowd out investment, not increase it. Additionally, it will increase interest rates, not lower them. The explanation seems to be implying the opposite?
Ruby, an *increasing* budget deficit means that the govt has to borrow money, consequently mopping up excess cash (ie: reducing cash available for businesses to borrow), and increasing interest rates (since there is less money to be borrowed, the money that is lent will be lent at a higher rate). Reducing a budget deficit does the opposite: increasing money available for businesses to borrow, and also reducing the interest rates.
oh crap…I had it the other way around. Thanks!