The crowding out effect refers to
A) a permanent increase in taxes.
B) an increase in the interest rate caused by government borrowing.
C) the reinforcing impact of state and local tax changes on federal tax changes.
D) the impact of a tax rate increase when the aggregate supply function is horizontal.

Question

Quizplus · Accepted Answer

The crowding out effect occurs when government borrowing increases the demand for loanable funds, causing the interest rate to increase, which then reduces private investment. This is because private investors can no longer borrow at lower interest rates, and may not find it profitable to invest in projects that have a lower expected return than the higher interest rate they have to pay to borrow. The crowding out effect is more likely to occur when the economy is at or near full employment, where resources are fully utilized and there is less slack in the economy.

The Crowding Out Effect Refers to