Skip to content

CFA Level I · CFA Level I Exam · Fiscal Policy

A country's government runs a deficit and finances it by issuing bonds to private investors, while the central bank keeps its policy rate unchanged. An economist argues that the expansionary effect will be partly offset because the extra borrowing raises interest rates and reduces private investment. This argument is best described as:

This is the crowding-out effect. Deficit-financed borrowing increases demand for loanable funds and pushes up interest rates, which reduces private investment and offsets part of the fiscal stimulus. Ricardian equivalence concerns households saving more, and automatic stabilizers concern built-in tax and transfer changes.

  1. Athe crowding-out effectCorrect
  2. BRicardian equivalence
  3. Cthe automatic stabilizer effect

Explanation

Crowding out occurs when government borrowing raises interest rates and displaces private investment, offsetting part of the fiscal stimulus. Ricardian equivalence instead says households save more in anticipation of future taxes. Automatic stabilizers are tax and transfer features that change with the cycle.

Did you get it right without looking?

One question tells you little. A timed set on Fiscal Policy shows your real accuracy, how long you take and where you lose marks.

Practise Fiscal PolicyFree diagnostic mock

More Fiscal Policy questions