“Government debt has an important role to play in the determination of Rates of Return in an

economy.” Discuss and evaluate this statement.

Budget Deficit: When government total expenditure exceeds its total revenue in a given year.

Budget Surplus: When government total expenditure in a year is less than the tax revenue
collected, it experiences a budget surplus.

The government accumulation of deficit minus its surplus is referred to public debt or
Government Debt.

When government expenditure is greater than its revenue it becomes a borrower in the
Loanable funds market. Now since the government offers a higher interest rate on its issued
treasury notes, the supply of loanable funds decreases in the market because now the investors
find the treasury notes more attractive compare to other public sector investments in stock
market and private lending institutions. The fall in the supply of loanable funds from S lf to S1
would lead to increase in the interest rate in the economy.
The lower the price of bonds the higher the yield and higher the price of the bond the lower the
yield. As the US government issues new bonds to finance its $1.8 Trillion budget deficit, the
supply of bonds increases, lowering the prices. Since the face value of US bond is fixed, a lower
price equates to a higher interest rate.