Question

The decrease in consumption and investment interest-related spending that occurs when the interest rate rises as government spending increases is called:

Select one:

a. crowding in.

b. crowding out.

c. neutral.

d. none of the above

Answer 1

The government increases government spending to boost the economy. This increase in spending is usually financed by borrowing which leads to an increase in the interest rate in the economy. As the interest rate rises, the cost of borrowing increases, which leads to a decrease in private investment and consumption. So, the rise in government spending crowds out the private investment due to higher borrowing costs. This whole process is known as Crowding Out. Hence, the correct answer is Option B i.e. Crowding out.