The crowding-out effect is
A) strongest when the economy is at full employment.
B) strongest when the economy is in a deep recession.
C) weakest when there is demand-pull inﬂation.
D) equally strong, regardless of the state of the macroeconomy.

Question

Quizplus · Accepted Answer

The crowding-out effect occurs when increased government spending or borrowing results in a reduction in private investment, as interest rates are driven up. This is because the government is competing with private borrowers for funds, and lenders may prefer to lend to the government, which is seen as a more secure borrower. The crowding-out effect is strongest when the economy is at full employment, as there is less idle capacity for the government to draw on and increased demand for loanable funds. In a deep recession, there may be more idle capacity and less demand for loanable funds, which could mitigate the crowding-out effect to some extent. Demand-pull inflation, however, implies an excess of demand over supply, and the resulting increase in interest rates could exacerbate inflationary pressures.

The Crowding-Out Effect Is