Chapter 13

Question 1

Define Crowding Out

Answer 1

A reduction in private spending due to higher interest rates generated by budget deficits financed through government borrowing.

Question 2

What is the crowding out process?

Answer 2

1. Government conducts expansionary fiscal policy to bring economy out of a recession.
2. This increases the budget deficit (which must be financed through borrowing).
3. Government borrowing increases the demand for loanable funds (and, thus, the interest rate)
4. Increase in interest rates case consumption and investment to decrease. It also causes capital inflow to increase.