When a federal budget deficit causes crowding out:
A)real GDP does not increase by as much as the government purchases of goods and services multiplier would predict because bond-holders' saving declines.
B)real GDP does not increase by as much as the government purchases of goods and services multiplier would predict because investment declines.
C)interest rates fall, reducing the burden of the debt.
D)interest rates fall, bringing the current deficit back down.
E)interest rates fall, so that decreases in investment and government purchases of goods and services exactly offset the expansionary effect of the deficit.

Question

Quizplus · Accepted Answer

When the government sells securities to the public,the money supply will decrease (recall our discussion from Chapter 15 of what happens when the RBA sells securities to banks.The cash rate rises,which flows on to other rates).This will raise interest rates,which will reduce investment as some projects do not go ahead,or some consumers decide not to borrow money for a house.So even though expansionary fiscal policy will result in a net increase in real output,it will not be as large as it would have been if investment and consumption hadn't declined.

When a Federal Budget Deficit Causes Crowding Out