Conventional Wisdom has it that Large Deficits GMAT Reading Comprehension

Reading Passage Question

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.

‘Conventional wisdom has it that large deficits in the United States budget cause interest rates to rise.’ is a GMAT reading comprehension passage with answers. Candidates need a strong knowledge of English GMAT reading comprehension.

This GMAT Reading Comprehension consists of 4 comprehension questions.The GMAT Reading Comprehension questions are designed for the purpose of testing candidates’ abilities in understanding, analyzing, and applying information or concepts. Candidates can actively prepare with the help of GMAT Reading Comprehension Practice Questions.

Solution and Explanation

1. Which of the following best summarizes the central idea of the passage?

(A) A decrease in nongovernment borrowing or an increase in the availability of credit can eliminate or lessen the ill effects of increased borrowing by the government.
(B) Educating financiers about the true relationship between large federal deficits and high interest rates will make financiers less prone to raise interest rates in response to deficits.
(C) There is little support for the widely held belief that large federal deficits will create higher interest rates, as the main arguments given to defend this claim are flawed.
(D) When the government borrows money, demand for credit increases, typically creating higher interest rates unless special conditions such as decreased consumer spending arise.
(E) Given that most financiers believe in a cause-and-effect relationship between large deficits and high-interest rates, it should be expected that financiers will raise interest rates.

2. 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

3. Which of the following claims concerning the United States government's financing of the deficit does the author make in discussing the second argument?

(A) The government will decrease the money supply in times when the government does not have a deficit to finance.
(B) The government finances its deficits by increasing the money supply whenever the economy is expanding.
(C) As long as the government finances the deficit by borrowing, nongovernment borrowers will pay higher interest rates.
(D) The only way for the government to finance its deficits is to increase the money supply without regard for whether such an increase would cause inflation.
(E) Inflation should be caused when the government finances the deficit by increasing the money supply only if there is not enough room for economic growth to support the increase.

4. The author uses the term "admittedly" (see highlighted text) in order to indicate that

(A) the second argument has some truth to it, though not for the reasons usually supposed
(B) the author has not been successful in attempting to point out inadequacies in the two arguments
(C) the thesis that large deficits directly cause interest rates to rise has strong support after all
(D) financiers should admit that they were wrong in thinking that large deficits will cause higher inflation rates
(E) financiers generally do not think that the author's criticisms of the second argument are worthy of consideration

Suggested GMAT Reading Comprehension Samples

• Nitrogen, Which Comprises 78 Percent of Earth's Atmosphere GMAT Reading Comprehension.
• An Experiment Conducted Aboard Space Lab in 1983 GMAT Reading Comprehension
• Coral Reefs Increasingly Face a Number of Threats GMAT Reading Comprehension
• Shortness, Reduced Mobility and Sore Joints May not Come to Mind GMAT Reading Comprehension
• When I Talk About UFOs in my Introductory Astronomy Classes GMAT Reading Comprehension
• There is a New Cell-Phone Ring Tone that can't be Heard by Most People GMAT Reading Comprehension
• A Growing Taste for Shark Steaks and Shark-Fin Soup has for the First Time in 400 Million Years GMAT Reading Comprehension
• Erythropoietin, Known also as EPO, is a Glycoprotein Hormone that Controls the Production of Red Blood Cells GMAT Reading Comprehension
• Ideas Involving the Theory of Probability Play a Decisive Part in Modern Physics. GMAT Reading Comprehension
• Isolated From the Rest of the World by Circumpolar Currents and Ice Fields, the Dry Valleys of Antarctica Never See Snowfall. GMAT Reading Comprehension
• In the Fast New Choreography of American Compassion, Explanation is Twirled into Excuse GMAT Reading Comprehension
• No One Thing Over Which we have Control Exerts so Marked an Influence Upon our Physical Prosperity GMAT Reading Comprehension
• The Spotted Hyenas, or Crocuta Crocuta, Found Through Sub-Saharan Africa GMAT Reading Comprehension
• For Biologists, The Term “eye” Describes any Light-Sensitive Organ GMAT Reading Comprehension
• Newton’s Surprising Success at Developing the Laws of Motion GMAT Reading Comprehension
• Physical Theory Implies that the Existence of Astronomical Entities GMAT Reading Comprehension
• The Study of Climate Change has Established Retreating Glaciers GMAT Reading Comprehension
• Every culture that has adopted the cultivation of maize​ GMAT Reading Comprehension
• At the present time, 98% of the world energy consumption GMAT Reading Comprehension
• The Internet makes possible the instantaneous transmission​ GMAT Reading Comprehension