A country initially has an equilibrium real interest rate of 4 per cent and an equilibrium quantity of investment of $2 trillion. The government's budget deficit then increases. According to the crowding-out effect, the
A) demand for loanable funds curve shifts rightward, the real interest rate rises and investment decreases.
B) demand for loanable funds curve shifts rightward, the real interest rate falls and investment increases.
C) demand for loanable funds curve shifts leftward, the real interest rate falls and investment increases.
D) supply of loanable funds curve shifts rightward, the real interest rate rises and investment increases.
E) supply of loanable funds curve shifts leftward, the real interest rate falls and investment decreases.

Question

Quizplus · Accepted Answer

When the government's budget deficit increases, it borrows more, shifting the demand for loanable funds curve rightward. This increases the real interest rate and decreases investment, illustrating the crowding-out effect.

A Country Initially Has an Equilibrium Real Interest Rate of 4