Crowding Out Effect
Question
Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy?
Options
A situation where private investment increases due to increased Government spending
A situation where Government borrowing leads to higher interest rates, which reduces private investment
A situation where an increase in taxes leads to increased private sector investment
A situation where Government spending has no impact on aggregate demand
Explanation
The correct answer is (b). In macroeconomic theory, the Crowding Out Effect occurs when expansionary fiscal policy and increased government borrowing absorb a large share of available loanable funds in the financial market. This increased demand drives up institutional interest rates, which increases borrowing costs for corporations and reduces private sector capital investment.
Question details
Year
2026
Paper
GS Paper 1
Question
Q59
Subject
Economy
Sub-topic
Fiscal Policy, Taxation & Budget
Type
Factual single
Difficulty
Easy
Nature
Static
Source hint
NCERT Economics Cl.12 Macroeconomics Ch.5 Fiscal Policy
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