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3) In what type of economy would you expect crowding out to be least problematic (and...

3) In what type of economy would you expect crowding out to be least problematic (and why) AND in what type of economy would you expect crowding out to be worse (and why)?

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Answer #1

Crowding out is the reduction in availability of funds for private investment when government spending increases the rate of interest and displaces private investment. If the economy has a capital market which is very insensitive to the interest rate then it implies that government borrowing will not influence private investment. That situation there will be very little or no crowding out. However if the investment is very sensitive to the interest rate then there will be a huge crowding out.

Therefore, for crowding out to be least effective we must have an economy where investment is very insensitive to interest rate. For crowding out to be most effective the economy must have investment which is highly sensitive to interest rate.

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