Selling bonds to banks methods of government deficit finance is MOST likely to crowd out private investment
What is crowding out of private investment?
Definition: A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect.
How government deficits can crowd out private investment?
If budget deficits are to be financed by borrowing, interest rates must rise so that capital markets can reach equilibrium. High interest rates, in turn, result in a decreased investment, hence the crowding-out effect.
What does it mean for banks to sell bonds?
When a central bank buys bonds, money is flowing from the central bank to individual banks in the economy, increasing the money supply in circulation. When a central bank sells bonds, then money from individual banks in the economy is flowing into the central bank—reducing the quantity of money in the economy.
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