. Does government budget deficit “crowds out”, investment spending? &

. Does government budget deficit “crowds out”, investment spending?

Us no more than one paragraph to support your response using economic reasoning

Expert Solution

A budget deficit by the government, i.e. increase in government spending or decrease in tax rate as a part of the expansionary fiscal policy can lead to crowding out of investment. As spending is higher than receipts, this induces borrowings by the government. Thus, at existing supply of credit, the demand is higher and this leads to increase in interest rate for borrowing financial capital. Therefore, an increased government spending leads to higher interest rates. Increasing interest rates negatively affect private investments, thus, giving evidence to crowding out of private investment. The stimulus to increase spending and income in the economy gets crowded out due to a limit in increase in private investment spending. The degree of this crowding out depends on the sensitivity of investment to interest rate changes and that of interest rate to availability of credit in the financial market.

Rahul Sunny answered 1 year ago

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