Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy ?
A
A situation where private investment increases due to increased Government spending
B
A situation where Government borrowing leads to higher interest rates, which reduces private investment
Correct answer
C
A situation where an increase in taxes leads to increased private sector investment
D
A situation where Government spending has no impact on aggregate demand
Explanation
Crowding out occurs when heavy government borrowing raises demand for loanable funds and pushes up interest rates, making borrowing dearer for private firms and reducing private investment. It is a key argument for fiscal consolidation.
Public FinanceFiscal policy: crowding outCrowding outGovernment borrowingInterest ratesPrivate investmentFiscal deficit