Economics • Economic BasicsMedium
Which of the following describes 'Crowding Out Effect' in fiscal policy?
A. Increase in government borrowing leads to a rise in interest rates, thereby reducing private investment✓ Correct Answer
B. Expansionary monetary policy increases money supply and lowers consumer spending
C. Higher tax rates stimulate private sector capital formation and entrepreneurship
D. Government expenditure directly replaces consumer consumption of luxury goods
💡 Solution & Explanation
The crowding out effect occurs when increased government borrowing drives up market interest rates, making loans expensive and thereby discouraging private sector investment spending. This economic phenomenon dampens the expansionary impact of fiscal deficits. Monetarists frequently highlight this limitation when arguing against excessive deficit-financed public expenditures.
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