Question

Discuss the possible impact of budget deficits on interest rates and private investment in small island economies in the Pacific.

Answer 1

Explanation:

terms of low inflation and low budget deficits. Most of these economies have, however possible, comparisons are made with small island of high real interest rates in Pacific island.

Answer 2

A govt budget balance is determined by the difference in revenues (mostly taxes) & spending. A "positive balance" is a surplus, & a "negative balance" is a deficit.

Explanation:

• In the macro-economic analysis of fiscal policy, the impact of fiscal deficits on economic growth are significant. Many economic models indicate that budget deficits reduced inflation by higher interest rates and diverting private contributions from investment to govt debt.
• The budget deficit is related to long-term interest rates. Any attempt to decrease the estimated amount of potential national savings puts additional pressure on short-term projected interest rates
• By comparison, higher interest rates would raise potential budget deficits, decrease domestic investment, and decrease potential production levels. Domestic investment is funded primarily from national/domestic savings.
• In comparison, bond prices decline as interest rates increase. When the government increases the deficit by issuing debt, low prices raise borrowing costs.
• Budgetary deficits have a worrying effect on private investment. If borrowing is to cover budget deficits, interest rates need to raise in order to maintain a balance in "capital markets". In addition, high interest rates tend to lower investment, which is why there is a "crowding out" impact.
• A "crowding-out" is an detrimental effect of budget deficits, wherein higher interest rates results in reduced private investment, lower exchange prices and less exports
• An empirical correlation between deficits and higher interest rates or decreased spending has, however, been difficult to establish in practice. Indeed, for several years, interest rates have remained low, although deficits were high.

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