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Conventional wisdom has it that large deficits in the United States bu
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18 Jul 2022, 01:04
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Conventional wisdom has it that large deficits in the United States budget cause interest rates to rise. Two main arguments are given for this claim. According to the first, as the deficit increases, the government will borrow more to make up for the ensuing shortage of funds. Consequently, it is argued, if both the total supply of credit (money available for borrowing) and the amount of credit sought by nongovernment borrowers remain relatively stable, as is often supposed, then the price of credit (the interest rate) will increase. That this is so is suggested by the basic economic principle that if supplies of a commodity (here, credit) remain fixed and demand for that commodity increases, its price will also increase. The second argument supposes that the government will tend to finance its deficits by increasing the money supply with insufficient regard for whether there is enough room for economic growth to enable such an increase to occur without causing inflation. It is then argued that financiers will expect the deficit to cause inflation and will raise interest rates, anticipating that because of inflation the money they lend will be worth less when paid back.
Unfortunately for the first argument, it is unreasonable to assume that nongovernment borrowing and the supply of credit will remain relatively stable. Nongovernment borrowing sometimes decreases. When it does, increased government borrowing will not necessarily push up the total demand for credit. Alternatively, when credit availability increases, for example through greater foreign lending to the United States, then interest rates need not rise, even if both private and government borrowing increase.
The second argument is also problematic. Financing the deficit by increasing the money supply should cause inflation only when there is not enough room for economic growth. Currently, there is no reason to expect deficits to cause inflation. However, since many financiers believe that deficits ordinarily create inflation, then admittedly they will be inclined to raise interest rates to offset mistakenly anticipated inflation. This effect, however, is due to ignorance, not to the deficit itself, and could be lessened by educating financiers on this issue.
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Question Stats:
76% (02:18) correct
24% (01:52) wrong based on 17 sessions
1. Which of the following best summarizes the central idea of the passage?
(A) A decrease in nongovernment borrowing or an increase in the availability of credit can eliminate or lessen the ill effects of increased borrowing by the government. (B) Educating financiers about the true relationship between large federal deficits and high interest rates will make financiers less prone to raise interest rates in response to deficits. (C) There is little support for the widely held belief that large federal deficits will create higher interest rates, as the main arguments given to defend this claim are flawed. (D) When the government borrows money, demand for credit increases, typically creating higher interest rates unless special conditions such as decreased consumer spending arise. (E) Given that most financiers believe in a cause-and-effect relationship between large deficits and high interest rates, it should be expected that financiers will raise interest rates.
Question 2
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31% (01:12) correct
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2. It can be inferred from the passage that proponents of the second argument would most likely agree with which of the following statements?
(A) The United States government does not usually care whether or not inflation increases. (B) People in the United States government generally know very little about economics. (C) The United States government is sometimes careless in formulating its economic policies. (D) The United States government sometimes relies too much on the easy availability of foreign credit. (E) The United States government increases the money supply whenever there is enough room for growth to support the increase
Question 3
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81% (01:48) correct
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3. Which of the following claims concerning the United States government's financing of the deficit does the author make in discussing the second argument?
(A) The government will decrease the money supply in times when the government does not have a deficit to finance. (B) The government finances its deficits by increasing the money supply whenever the economy is expanding. (C) As long as the government finances the deficit by borrowing, nongovernment borrowers will pay higher interest rates. (D) The only way for the government to finance its deficits is to increase the money supply without regard for whether such an increase would cause inflation. (E) Inflation should be caused when the government finances the deficit by increasing the money supply only if there is not enough room for economic growth to support the increase.
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4. The author uses the term "admittedly" (see highlighted text) in order to indicate that
(A) the second argument has some truth to it, though not for the reasons usually supposed (B) the author has not been successful in attempting to point out inadequacies in the two arguments (C) the thesis that large deficits directly cause interest rates to rise has strong support after all (D) financiers should admit that they were wrong in thinking that large deficits will cause higher inflation rates (E) financiers generally do not think that the author's criticisms of the second argument are worthy of consideration
Re: Conventional wisdom has it that large deficits in the United States bu
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19 Jul 2022, 02:01
2
Expert Reply
1. Which of the following best summarizes the central idea of the passage? A. A decrease in nongovernment borrowing or an increase in the availability of credit can eliminate or lessen the ill effects of increased borrowing by the government.passage never says the borrowing is evil. Neither does it shows ways to reverse the effects of government borrowing B. Educating financiers about the true relationship between large federal deficits and high interest rates will make financiers less prone to raise interest rates in response to deficits.There is no educating financers. Financers are merely a case in point that how half truths can lead to faulty reasons to adopt a policy. C. There is little support for the widely held belief that large federal deficits will create higher interest rates, as the main arguments given to defend this claim are flawed.Yes. It brings into question the validity of a popular belief, highlights 2 arguments used to rationalise this popular belief and calls the arguments into question. D. When the government borrows money, demand for credit increases, typically creating higher interest rates unless special conditions such as decreased consumer spending arise. Decreased consumer spending doesnt come into the picture anywhere in the passage E. Given that most financiers believe in a cause-and-effect relationship between large deficits and high interest rates, it should be expected that financiers will raise interest rates.This is just one of the arguments targetted by the author. This point is used to show how a popular belief can lead to faulty adoption of policies.
2. It can be inferred from the passage that proponents of the second argument would most likely agree with which of the following statements? A. The United States government does not usually care whether or not inflation increases.There is nothing in the passage to support this B. People in the United States government generally know very little about economics.There is nothing in the passage to support this C. The United States government is sometimes careless in formulating its economic policies.Could be true. It does seem to resonate with the tone of the passage D. The United States government sometimes relies too much on the easy availability of foreign credit.Passage never discourages nor encourages foreign credit. E. The United States government increases the money supply whenever there is enough room for growth to support the increase.Goes against the passage. Passage states that there are times when money supply is increased even when there is no room for growth in the economy.
3. Which of the following claims concerning the United States government's financing of the deficit does the author make in discussing the second argument? A. The government will decrease the money supply in times when the government does not have a deficit to finance.Argument never says this. It does say that the govt may increase the money supply when it has a deficit to finance. B. The government finances its deficits by increasing the money supply whenever the economy is expanding."economy expanding"? OFS since this term is not used in the passage C. As long as the government finances the deficit by borrowing, nongovernment borrowers will pay higher interest rates.Disctinction between govt and non-govt borrowers is not used in the 2nd argument. That distinction is only used in the 1st argument. D. The only way for the government to finance its deficits is to increase the money supply without regard for whether such an increase would cause inflation."only way"? The argument never uses any restrictive terms like that. E. Inflation should be caused when the government finances the deficit by increasing the money supply only if there is not enough room for economic growth to support the increase.Perfect.
4. The author uses the term "admittedly" (see highlighted text) in order to indicate that A. the second argument has some truth to it, though not for the reasons usually supposedYes. The argument only has truth to it because financiers believe popularly held belief and make a decision based on that. B. the author has not been successful in attempting to point out inadequacies in the two argumentsNothing in the passage to believe this C. the thesis that large deficits directly cause interest rates to rise has strong support after allOn the contrary the passage argues the other way D. financiers should admit that they were wrong in thinking that large deficits will cause higher inflation ratesThe passage never blames financers for anything. On the contrary, it makes them look like the victims of popular belief. E. financiers generally do not think that the author's criticisms of the second argument are worthy of considerationFinancers are used as an object in the passage. They never do anything other than make passive judgements based on popular belief
gmatclubot
Re: Conventional wisdom has it that large deficits in the United States bu [#permalink]
18 Jul 2022, 01:04
76% (02:18) correct
