Question:
The term ‘Crowding-out effect’ refers to the situation where
(1) increased private investment reduces government spending.
(2) increased government borrowing drives up interest rates and reduces private investment.
(3) increased taxes reduce consumer spending.
(4) increased imports reduce demand for domestically produced goods.
(5) inflation reduces the purchasing power of consumers.
Correct Answer:
(2)
Answer Explanation:
When a government runs a large budget deficit, it must borrow heavily from the domestic financial markets. This massive demand for loanable funds drives up the market interest rates. The higher borrowing costs “crowd out” private sector businesses, forcing them to reduce their private investment.
Topic: Public Finance Year: 2019
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