The crowding-out effect stresses that
A) an increase in government expenditures will stimulate aggregate demand and, thereby, help to prevent recessions.
B) an increase in taxes will restrain aggregate demand and, thereby, help to control inflation.
C) additional government borrowing to finance a larger deficit will increase the demand for loanable funds, causing real interest rates to rise.
D) a budget deficit is a highly effective tool with which to combat recessions.
E) both a and d are correct.

Question

Quizplus · Accepted Answer

The crowding-out effect refers to the increase in interest rates and decrease in private investment that can occur when the government borrows more money to finance a larger deficit. This is because the additional demand for loanable funds from the government competes with the private sector for available funds, causing interest rates to rise. As a result, private investment may decline due to the higher borrowing costs. Choice A is incorrect because while an increase in government spending may stimulate aggregate demand, it can also contribute to the crowding-out effect. Choice B is incorrect because taxes are not directly related to the crowding-out effect. Choice D is incorrect because while a budget deficit may be used to combat recessions, it can also contribute to the crowding-out effect. Choice E is incorrect because only choice C is correct.

The Crowding-Out Effect Stresses That