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Ivanshal [37]
4 years ago
7

The crowding-out effect works through interest rates to: 
A. Increase the effectiveness of expansionary fiscal policy
B. Decreas

e the effectiveness of expansionary fiscal policy
C. Decrease the effectiveness of contractionary fiscal policy
D. Increase the effectiveness of contractionary fiscal policy
Business
1 answer:
neonofarm [45]4 years ago
5 0

Answer: Option (B) is correct.

Explanation:

Suppose there is an increase in the government spending which means that it is a expansionary fiscal policy, this will also results in an increase in the government borrowings. Now, this increase in the government borrowings will increase demand for the loanable funds, as a result interest rate increases. This rise in the interest rate will lead to a reduction in investment spending.

Hence, the government spending crowding out the investment spending. Therefore, crowding out reduces the effect of expansionary fiscal policy.

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