According to the crowding-out effect, how do the interest rate and investment spending change when government spending increases?
A) The interest rate and investment spending both increase.
B) The interest rate increases and investment spending decreases.
C) The interest rate decreases and investment spending increases.
D) The interest rate and investment spending both decrease.

Question

Quizplus · Accepted Answer

The crowding-out effect states that when the government increases its spending, it increases the demand for loanable funds, which raises the interest rate. This increase in interest rate makes borrowing more expensive for private firms, which leads to a decrease in investment spending. Therefore, the correct answer is B, as the interest rate increases and investment spending decreases.

According to the Crowding-Out Effect, How Do the Interest Rate