3. TRUE/FALSE/MAYBE and EXPLAIN: (4 MARKS). (Maximum length: one page) "A government sells a large amount of new bonds to finance an immediate cut in personal income taxes. According to the Loanable Funds and Money Market models this will lower short- and long-run real interest rates (ceteris paribus)."

Answer: A Cut in the personal income tax will increase the supply of loanable fund form S1 to S2 in the figure as people is able to save more. Immediate sale of large amount of new bonds will increase the demand for money from D1 to D2 in the figure by the government as a crowding out effect. So, the new equilibrium will shift form E1 to E2 which is higher than that of previous interest rate. Thus, it is not sure that such effect will decrease the interest rate for loanable funds there may increase, decrease and remain same it will depend upon quantity of sale of bonds. As it can be seen if D2 will shift far form D1 then interest rate will increase and vice-versa.