Following severe flooding in 2022, the government of Lydora proposes borrowing from pension funds to rebuild roads and drainage. The loans will be repaid ov...
Question 1 Report
Following severe flooding in 2022, the government of Lydora proposes borrowing from pension funds to rebuild roads and drainage. The loans will be repaid over 15 years from future tax income. Public spending will increase, but some economists warn that the budget deficit and public debt may grow.
(a) State what is meant by a budget deficit. [2]
(b) Explain one reason why lenders may be willing to provide funds to a government. [2]
(c) Analyse one possible effect of increased government borrowing on economic growth. [3]
(d) Assess whether higher government borrowing is likely to be beneficial for Lydora's economy. [2]
Answer Details
(a) A budget deficit occurs when government expenditure is greater than government revenue, such as tax receipts, [1] over a stated period, usually one year. [1]
(b) Lenders may be willing to lend because governments are generally seen as relatively low-risk borrowers and are expected to repay. [1] They can also receive interest income on the loan. [1] A predictable long-term return from interest payments is another valid explanation.
(c) Borrowing can finance the rebuilding of drainage and roads. [1] Better roads can improve transport, while drainage can reduce disruption from flooding, lowering firms' costs. [1] Firms may then produce and invest more, increasing output and economic growth. [1]
(d) Higher borrowing may be beneficial because improved infrastructure can support higher growth. [1] However, repayment and interest payments may require higher future taxes or lower future public spending. The outcome depends on whether the growth benefits exceed these costs. [1]
Borrowing is not automatically good or bad: consider both what the funds finance and the future cost of servicing the debt.
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