The crowding-out effect suggests that
A) expansionary fiscal policy causes inflation.
B) restrictive fiscal policy is an effective weapon against inflation.
C) a reduction in private spending that results from higher interest rates caused by a budget deficit will largely offset the expansionary effects of the deficit.
D) a tax reduction financed by borrowing will increase the disposable income of households and, thereby, lead to a strong expansion in aggregate demand, output, and employment.

Question

Quizplus · Accepted Answer

The crowding-out effect suggests that the increase in government spending financed by borrowing will increase interest rates, which in turn reduces private investment and consumption. This reduction in private spending offsets the anticipated expansionary effects of the government's fiscal expansion. Therefore, Option C is the correct answer, which explains that a reduction in private spending resulting from higher interest rates caused by a budget deficit will largely offset the expansionary effects of the deficit.

The Crowding-Out Effect Suggests That