The crowding-out effect indicates that budget deficits
A) will stimulate aggregate demand and, therefore, exert a strong impact on output and employment.
B) will lead to additional borrowing and higher interest rates that will reduce the level of private spending.
C) are highly appropriate when the threat of inflation is present.
D) are highly appropriate when the threat of recession is present.

Question

Quizplus · Accepted Answer

The crowding-out effect occurs when the government borrows more money, leading to higher interest rates and a decrease in private spending. This reduces the impact of government spending on the economy and can lead to a decrease in output and employment. Therefore, option B is the correct answer. Option A is incorrect because budget deficits can only stimulate demand up to a certain point, beyond which the crowding-out effect becomes more significant. Option C is incorrect because budget deficits actually contribute to inflationary pressures, and Option D is incorrect because deficits should only be used during recessions if they are necessary to counteract the economic downturn.

The Crowding-Out Effect Indicates That Budget Deficits