If the government increases spending through fiscal policy, what is the likely impact on interest rates?

When the government increases spending through fiscal policy, it typically leads to higher demand in the economy. This increase in demand can stimulate economic activity, which may prompt the government to borrow more to finance its spending. As the government issues more bonds to fund this increase, the supply of bonds in the market rises.

As a result of the increased supply of government bonds, investors will demand a higher interest rate to compensate for holding these new securities. This situation occurs because, according to the law of supply and demand, when the supply of a good (in this case, government bonds) increases significantly, the price of that good tends to drop. The price of bonds is inversely related to interest rates; therefore, when bond prices fall, interest rates increase.

In addition to the direct impact of government borrowing, the expectation of higher future inflation due to increased government spending can also lead to higher interest rates, as lenders seek to maintain their returns in real terms.

Overall, the combination of increased government demand for borrowing and potential inflationary expectations suggests that interest rates are likely to rise in response to an increase in government spending through fiscal policy.