Interest rate

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Interest rate

by gasg » Fri Feb 04, 2011 3:18 pm
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.


Q1)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.

Confuse between A and C

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by Adam@Knewton » Sat Feb 05, 2011 9:57 pm
How about a hint: There's one word in (A) and one word in (C), having nothing to do with the passage's details, but giving a hint as to the degree of certainty of the choice. Which of the two choices is a little big less extreme, and therefore more likely to be inferrable from the passage?
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by chendawg » Wed Feb 16, 2011 4:56 pm
I would go with A.

In the passage it states:

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. The key words are insufficient regard here.

A states: The United States government does not usually care whether or not inflation increases.

The key word is usually; this statement basically says the US Gov't doesn't really care much whether or not inflation increases, but could care more if it got out of hand. From the statement given in the passage, it says the government increases the money supply with insufficient regard to whether it causes inflation. This basically means that the government does care to a certain extent, but mostly it doesn't. This closely matches answer choice A.

C states: The United States government is sometimes careless in formulating its economic policies.

This answer choice says that the US Gov't is sometimes careless in formulating its policies. Careless is the key word here, as it is saying that the government sometimes has no care in formulating its policies. Again, the key statement from the passage is the same one as above:

"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."

Insufficient regard indicates that the U.S. Gov't does give SOME care to its policies, not completely without care. Hence c is a wrong answer.
Last edited by chendawg on Thu Feb 17, 2011 1:00 pm, edited 1 time in total.

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by powerpuff » Thu Feb 17, 2011 1:25 am
+1 for option A. Chendawg has given a good explanation

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by navami » Fri Mar 04, 2011 10:03 pm
I picked C. What is OA? Even I am stuck in between A and C :(
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by HSPA » Mon Mar 07, 2011 4:00 am
If it is btw A and C. Then as per Adam Knewton's hint it shall be C.

A is a little extreme saying USA does not care for inflation.
C says govt sometimes make mistakes.
B is also very extreme..

IMO C

My feel is ....Paragraph is tough and is for a Economic professor but question is easy and is for us.

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by archimittal » Tue Mar 08, 2011 1:27 am
AdamKnewton wrote:How about a hint: There's one word in (A) and one word in (C), having nothing to do with the passage's details, but giving a hint as to the degree of certainty of the choice. Which of the two choices is a little big less extreme, and therefore more likely to be inferrable from the passage?
Hi Adam

Thanks for the insight. So would you suggest we avoid extreme options on all inference questions?

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by iamharish » Thu Mar 10, 2011 11:28 pm
I picked A as I felt C was very generic abt overall US policies including bt nt limited to the deficit handling.
A, though being extreme, was abt the current issue....
Bt nw i feel even C can gel as well :(
curious abt the OA...wats it?

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by anirudhbhalotia » Mon Apr 04, 2011 3:11 am
If I take a cue from Adam,

Then C is the one I would go for. Its "less extreme" than A.

The difference is "usually" and "sometimes".
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by bubbliiiiiiii » Wed Apr 06, 2011 5:45 am
Based on Adam's hint, I would choose sometimes over 'doesnot usually' to be less extreme.

IMO C.

OA Please.
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by chendawg » Wed Apr 06, 2011 5:58 am
Honestly what I think Adam was talking about is care vs. careless, NOT usually vs. sometimes. Usually and sometimes is very close in the scope of things.
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by arjmenon » Thu May 26, 2011 12:23 pm
Its c cause a is too extreme.

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by sharmishtha_goel » Tue Jul 26, 2011 11:44 am
why is the answer not E . Isn't that stated in the 1st paragraph??

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by SticklorForDetails » Tue Jul 26, 2011 12:01 pm
sharmishtha_goel wrote:why is the answer not E . Isn't that stated in the 1st paragraph??

TIA
No, (E) contradicts the second argument, which states that the government will act "with insufficient regard," thus not with any expectation as (E) suggests.

Five months ago, I was in fact talking about "does not usually care" vs. "sometimes careless," which as many people pointed out should lean us towards (C). The government "will tend" to act "with insufficient regard," meaning they do care maybe a little but not enough, sometimes. Although very vague -- or perhaps *because* it is very vague -- (C) manages to capture this: the government may sometimes be careless.

(A) also is slightly off in the scope of its specifics. The government acts without sufficient egard for "whether there is enough room for economic growth" so as not to lead to inflation. This is not the same as saying the government doesn't care about inflation. Imagine that you go shopping without checking if the milk you have at home has gone bad, and therefore that you should buy some. This doesn't mean you don't care about milk; it means you don't always pay attention to whether it's spoiled.

Thus the answer is (C).

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by nonameee » Mon Feb 06, 2012 1:16 pm
I didn't like the wording in (C): formulating its economic policies. To formulate is not the same as to act. The passage talks about the government's financing its deficit through printing more money. I'm not quite sure that it is the same as formulating a policy.

Could someone please shed a light on this objection?