CFA Level I · CFA Level I Exam · Fiscal Policy
A government increases its deficit to fund spending. Interest rates rise and private firms cut capital expenditure as a result. This outcome is most likely an example of:
This is crowding out. Deficit financing raises interest rates, which makes borrowing costlier for businesses and reduces private investment, partly offsetting the expansionary effect of the government's higher spending.
- Acrowding outCorrect
- Bautomatic stabilization
- Ca balanced budget multiplier
Explanation
Government borrowing raises demand for loanable funds and interest rates, which displaces private investment. This is crowding out and reduces the net effect of fiscal expansion. Automatic stabilizers are tax and transfer changes that respond to the cycle without new decisions.
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