The current market rate of interest is 8 percent. At that rate of interest, businesses borrow $500 billion per year for investment and consumers borrow $100 billion per year to finance purchases. The government is currently borrowing $100 billion per year to cover its budget deficit.
A) Derive the market demand for loanable funds, and show how investors and consumers will be affected if the budget deficit increases to $200 billion per year.
B) Show the impact on the market rate of interest, assuming that taxpayers do not anticipate any future tax increases.
C) How would your conclusion differ if taxpayers fully anticipate future tax increases?
D) Suppose 90 percent of the net federal debt was acquired by foreign investors. How would this affect the burden of the debt for U.S. citizens?