The crowding-out effect tends to be stronger when the economy
A) has a lot of excess productive capacity.
B) is at, or close to, full employment.
C) has a very small net exports or foreign sector.
D) is a very open economy with a large foreign sector.

Question

Quizplus · Accepted Answer

The crowding-out effect occurs when an increase in government spending leads to a decrease in private investment. This happens because the increase in government spending leads to an increase in interest rates, which makes borrowing more expensive for businesses and individuals. This tends to be stronger when the economy is at or close to full employment, as there is less excess capacity to absorb the increase in demand from government spending.

The Crowding-Out Effect Tends to Be Stronger When the Economy