ACCA Applied Knowledge · Business and Technology · Macroeconomic factors
A government increases its spending on infrastructure and, as a result, interest rates rise because the extra borrowing competes with private sector borrowers for funds, reducing private investment. What is this effect called?
This is called crowding out. Extra government borrowing competes for available funds, pushing up interest rates and discouraging private sector investment. It differs from the multiplier effect, which describes the amplified increase in national income from additional spending, and from fiscal drag, which concerns tax bands.
- AThe multiplier effect
- BCrowding outCorrect
- CFiscal drag
- DThe Laffer effect
Explanation
Crowding out occurs when higher government borrowing pushes up interest rates and reduces private sector investment. The multiplier is the amplified rise in income from extra spending. Fiscal drag relates to taxpayers moving into higher tax bands as incomes rise.
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