Question:
The crowding-out effect describes which of the following?
(1) When the government borrows money to finance budget deficit, it competes with private borrowers and bids up the interest rates causing private investment to decrease.
(2) When the government increases money supply rather than raise interest rates, inflation rate and private investment increase.
(3) When business firms compete for investment projects, the competition crowds out the weakest companies resulting in business failures.
(4) When the government repurchases bonds in the money market, money supply decreases and private investors have to compete for loans.
(5) When business sector borrows money they compete with the government and bid down the interest rates causing private investment to increase.
Correct Answer:
(1)
Answer Explanation:
The crowding-out effect occurs when aggressive government deficit spending absorbs available loanable funds in the financial markets. This increased demand for capital pushes interest rates up, which “crowds out” private sector businesses from taking out loans for investment.
Topic: Fiscal Policy Year: 2022
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