The crowding-out effect implies that restrictive fiscal policy will
A) increase aggregate demand and employment.
B) lead to a significant increase in the natural rate of unemployment.
C) be highly effective against inflation.
D) reduce real interest rates.

Question

Quizplus · Accepted Answer

The crowding-out effect occurs when government borrowing to finance a budget deficit increases demand for credit and leads to an increase in interest rates. This increase in interest rates can reduce private investment and consumption spending, leading to a decrease in aggregate demand and potentially causing a contraction in output and employment. Therefore, restrictive fiscal policy that includes a reduction in government spending or an increase in taxes can lead to a reduction in real interest rates and stimulate private investment and consumption spending.

The Crowding-Out Effect Implies That Restrictive Fiscal Policy Will