Economics • Economic BasicsMedium
What is the primary implication of 'Crowding Out' effect in fiscal economics when the government increases borrowing?
A. An increase in private sector investment due to higher aggregate demand
B. A reduction in private investment caused by higher interest rates resulting from government borrowing✓ Correct Answer
C. A sharp appreciation of the domestic currency in foreign exchange markets
D. An immediate reduction in consumer price inflation across retail markets
💡 Solution & Explanation
The crowding out effect occurs when increased government borrowing drives up the demand for loanable funds, pushing up interest rates and consequently discouraging private sector investment. This offsets the expansionary impact of fiscal policy measures. Alternative options misstate the direction of private investment response or confuse fiscal outcomes with monetary exchange rate adjustments. This concept highlights the limitation of debt-financed government spending.
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