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1 March, 11:49

Crowding out occurs when

A. increases in government spending cause interest rates to rise, reducing investment and consumption.

B. decreases in government spending cause interest rates to rise, reducing investment and consumption.

C. increases in taxes cause interest rates to rise, reducing investment and consumption.

D. increases in government spending cause interest rates to fall, reducing investment and consumption.

E. increases in investment and consumption cause interest rates to rise, reducing the ability of the government to borrow funds

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  1. 1 March, 12:49
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    The correct answer is A. increases in government spending cause interest rates to rise, reducing investment and consumption.

    Crowding out occurs when government spending exceeds limit and creates a shortfall. It is basically a macroeconomic situation originating from government's deficit spending. When the situation arises the government increases its spending more than it has, which forces it to borrow the rest to cover the gap. This shortfall increases interest rates and impacts corporate investments negatively. As the government, in an attempt to raise more funds, starts issuing government bonds which attracts most savers away from private bonds. Hence, it results in crowding out effect where the private institutions bear the brunt.
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