Question

Does the “crowding-out effect” of an expansionary fiscal policy make the policy more potent, or less? Explain briefly.

Answer 1

A ' crowding-out-effect' of an expansionary fiscal policy has less potent as it causes budget deficit. When government increases spending and lowers taxes in order to boost the economy, it is called expansionary fiscal policy. Government conducts expansionary fiscal policy to stimulate GDP and employment during recession. The increase in public spending during expansionary fiscal policy will shift the aggregate demand further than expected which will make government to sell government bonds in order to borrow money. Selling government bonds will increase interest rates which prevents private investing aloof causing 'crowding out effect'. The excess government borrowing to meet their expenditure will create adverse effects in the economy. Increased borrowing by the government will increase the market interest rate and less funds for private sectors as the loan amount given to government will be huge.   The long run crowding out effects are more serious as it reduces fiscal stimulus by decreasing in the spending of private investment which causes a reduction in the economic growth.