Chapter 14 Outline
IV. EFFECTS OF DEFICITS
A. General Comments
	1. The large budget deficits of the late 1980s were thought to have an adverse impact on the economy because they could (1) lead to inflation, (2) cause the interest rate to increase leading to a fall in investment and a decrease in the nation's growth rate, and (3) increase the trade deficit.
B. The Issuance of Treasury Bonds
	1. If the government finances the deficit by issuing bonds, interest rates will increase, thereby mitigating the expansionary effects of the deficit.
	a. The interest rate will increase because the issuance of bonds increases the demand for loanable funds.
	b. As the interest rate increases, investment will fall and the economy MI1 grow less rapidly.
	c. As the interest rate increases, the demand for U.S. dollars increases, driving up the relative price of net exports and increasing the trade deficit.
	2. If the economy is operating at less than full employment, the increase in the interest rate may be small.
	a. If the economy is operating at less than full employment, there is some justification for running a deficit.
C. The Issuance of Money
	1. If government finances the deficit by issuing money (selling U.S. Treasury securities to the Federal Reserve), the effect of the deficit will be more expansionary than if the deficit was financed by issuing Treasury bonds.
	a. The increase in the money supply is expansionary, and reinforces the effect of an increase in government spending.
	b. The increase in the money supply tends to lower interest rates, offsetting the increase in the interest rate caused by an increase in government spending.
	2. If the economy is operating at less than full employment, an increase in government spending financed by issuing money has no harmful effects on the economy and running a deficit is justified.

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