Suppose a country has a larger increase in debt in 2014 than it had in 2013. Then other things remaining the same,

a. the demand for loanable funds shifts rightward and the interest rate rises.

b. the supply of loanable funds shifts leftward and the interest rate rises.

c. the supply of loanable funds shifts rightward and the interest rate falls.

d. the demand for loanable funds shifts leftward and the interest rate falls.

Answer: Option (b) is correct.

Explanation:

If there is an increase in the national debt, as a result the supply of loanable funds shifts leftward and the interest rate rises. This means that economy is in budget deficit.

If the budget deficit increases in an economy, then the residents of that country will want to purchase fewer foreign assets and foreign residents wants to buy more of that country's assets.

The budget deficit in the economy has to be financed either by borrowing or by increasing taxes. This budget deficit occurred because of the tax cuts and higher government spending.

If a country running a budget deficit, which lead to reduction in national saving. We all know that interest rate is determined in the loan market, where savers supply the loans to the private borrowers.

So, if there is a fall in the national saving, this will reduced the supply of loans from savers, which raises the interest rate in an economy.

This will attract the foreign flow of capital. This means that demand for domestic assets increases because of the higher interest rate.