The crowding-out effect arises when:
A)government borrows in the money market, thus increasing interest rates and net investment spending in the economy.
B)government borrows in the money market, thus increasing interest rates and decreasing net investment spending.
C)the progressivity of the tax system increases, thus decreasing interest rates and increasing net investment spending.
D)the progressivity of the tax system decreases, thus decreasing interest rates and net investment spending.

Question

Quizplus · Accepted Answer

The crowding-out effect occurs when government borrowing in the money market increases interest rates, which in turn decreases net investment spending. This is because higher interest rates make it more expensive for firms to finance their investments, leading to a reduction in investment spending. Therefore, choice B is the correct answer. Choice A is incorrect because it mistakenly suggests that government borrowing will increase net investment spending, contrary to the crowding-out effect. Choices C and D are also incorrect because changes in tax progressivity do not directly affect interest rates or investment spending.

The Crowding-Out Effect Arises When