Economics • Economic BasicsHard
What is the primary economic implication of 'Crowding Out' when a government increases its borrowing through bond issuance?
A. Reduction in private sector investment due to higher prevailing interest rates✓ Correct Answer
B. Expansion of export volumes driven by a depreciating domestic currency
C. Immediate elimination of structural unemployment in manufacturing sectors
D. Permanent deflationary pressure caused by reduced money velocity
💡 Solution & Explanation
Crowding out occurs when increased government borrowing drives up interest rates, making it more expensive for private businesses to secure capital loans, thereby reducing private investment. This phenomenon dampens the expansionary impact of fiscal policy. It contrasts with the Keynesian view where government spending can stimulate idle resources without raising interest rates under liquidity trap conditions. Investment sensitivity to interest rates determines the exact magnitude of the crowding out effect.
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