What does the Classical model predict about the relationship between a

What does the Classical model predict about the relationship between a country’s budget balance (total revenue minus total spending) and a country’s level of real interest rates and investment in a closed economy? Use a graph of the capital

market to illustrate.

ANSWER

A higher budget deficit shifts the I+(G-T) curve to the right, increasing real interest rates. Higher real interest rates lead to a reduction in the quantity demanded of investment.