IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses
The government finances a larger budget deficit by issuing more bonds to private investors, and as a result market interest rates rise and some private firms cancel planned capital projects. Which term best describes this effect on business investment?
The effect is crowding out. Heavy government borrowing pushes up interest rates or absorbs available savings, which raises the cost of finance for firms and causes them to cut or postpone private investment, partly offsetting the expansionary effect of the deficit.
- ACrowding outCorrect
- BFiscal drag
- CThe accelerator effect
- DAutomatic stabilisation
- Supply-side incentive
Explanation
Crowding out occurs when government borrowing raises interest rates and reduces private investment. Fiscal drag concerns taxpayers moving into higher tax bands as incomes rise with inflation. The accelerator links investment to changes in output, not to government borrowing.
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