CFA Level I · CFA Level I Exam · Fiscal Policy
A government runs a deficit to finance a stimulus and the central bank leaves its policy rate unchanged. The most likely concern raised by critics about crowding out is that the additional government borrowing will:
Critics expect the extra borrowing to put upward pressure on interest rates and reduce private investment. This is crowding out: government demand for loanable funds raises borrowing costs, so private spending falls and partly offsets the stimulus intended by the deficit.
- Aput upward pressure on interest rates and reduce private investmentCorrect
- Blower interest rates and raise private investment
- Celiminate the budget deficit through higher saving
Explanation
Crowding out arises when greater government demand for loanable funds pushes up interest rates, which discourages private investment and offsets part of the stimulus. Lower rates or automatic deficit elimination are not the mechanism.
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