The federal government in the United States has been running large budget deficits.
a. Use a market for loanable funds graph to illustrate the effect of the federal budget deficits. What happens to the equilibrium real interest rate and the quantity of loanable funds? What happens to the level of saving and investment?
b. Now suppose that households believe that deficits will be financed by higher taxes in the near future, and households increase their saving in anticipation of paying those higher taxes. Briefly explain how your analysis in part (a) will be affected.