CFA Level I · CFA Level I Exam · Fiscal Policy
A country has a high debt-to-GDP ratio and investors begin to doubt its ability to repay. Which outcome is most likely to limit the government's ability to use expansionary fiscal policy?
Higher bond yields and difficulty selling new debt. If investors doubt repayment, they demand a risk premium or refuse to lend, so financing more deficits becomes expensive or infeasible, which restricts the government's ability to apply expansionary fiscal policy.
- ALower sovereign bond yields because investors seek safety
- BHigher bond yields and difficulty selling new debt, raising financing costsCorrect
- CA fall in the recognition lag so stimulus can be launched faster
Explanation
When investors doubt solvency they demand higher yields or refuse to buy new debt, so additional deficit spending becomes costly or impossible. Lower yields would ease constraints, and shorter lags are unrelated to debt sustainability. Large debt thus limits fiscal capacity.
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