How Government Borrowing Affects Investment and the Trade Balance

When governments are borrowers in financial markets, there are three possible sources for the funds from a macroeconomic point of view: (1) households might save more; (2) private firms might borrow less; and (3) the additional funds for government borrowing might come from outside the country, from foreign financial investors. Let’s begin with a review of why one of these three options must occur, and then explore how interest rates and exchange rates adjust to these connections.

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