Answer-The 'Crowding Out' effect of fiscal policy refers to:

Crowding Out is a potential negative consequence of expansionary fiscal policy increased government spending or tax cuts when it is financed by borrowing from the domestic loanable funds market . The government increases its demand for funds to finance its deficit. This increased demand competes with private borrowers firms wanting to invest for a limited supply of savings. This competition drives up the real interest rate . Higher interest rates make borrowing more expensive for private firms, leading them to postpone or cancel investment projects . Thus, the increase in public sector activity crowds out private sector investment, potentially reducing the overall effectiveness of the fiscal stimulus.

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The 'Crowding Out' effect of fiscal policy refers to:

Question

The 'Crowding Out' effect of fiscal policy refers to:

A Government spending increasing private investment. Correct Answer Incorrect Answer

B Government borrowing leading to higher interest rates, reducing private investment. Correct Answer Incorrect Answer

C Exports reducing domestic consumption. Correct Answer Incorrect Answer

D Imports replacing domestic production. Correct Answer Incorrect Answer

E Public sector enterprises outcompeting private firms. Correct Answer Incorrect Answer

Solution

Crowding Out is a potential negative consequence of expansionary fiscal policy (increased government spending or tax cuts) when it is financed by borrowing from the domestic loanable funds market .

The government increases its demand for funds to finance its deficit.
This increased demand competes with private borrowers (firms wanting to invest) for a limited supply of savings.
This competition drives up the real interest rate .
Higher interest rates make borrowing more expensive for private firms, leading them to postpone or cancel investment projects .
Thus, the increase in public sector activity "crowds out" private sector investment, potentially reducing the overall effectiveness of the fiscal stimulus.

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