What effect does increased government borrowing typically have on interest rates?

Increased government borrowing typically leads to higher interest rates due to the mechanics of supply and demand in the financial markets. When the government borrows more, it issues bonds to raise the necessary funds. This increased supply of bonds can lead to a rise in the interest rates associated with these bonds. As the government competes for available funds from investors, the return they must offer becomes more attractive to entice investors to buy the newly issued bonds.

Furthermore, higher government borrowing can also lead to concerns about inflation or increased fiscal deficits, further prompting investors to demand higher interest rates as compensation for perceived risks. This general trend can crowd out private investment; as interest rates rise, borrowing costs for businesses and consumers increase, potentially leading to reduced capital expenditure and spending in the economy.

Understanding this relationship is crucial in macroeconomics, as it illustrates how government fiscal policy can impact the broader economy through interest rate changes. Thus, increased government borrowing often correlates with increased interest rates, reinforcing the notion that government borrowing affects the availability and cost of financial resources in the economy.