5.5 Crowding Out

Front

Govt in budget deficit typically ____ to finance spending.

Back

borrows

Front

Crowding out refers to the adverse effect of increased government borrowing, leading to decreased interest-sensitive private sector spending.

Back

adverse, decreased

Front

Long-run impact of crowding out: lower rate of physical capital accumulation and less economic growth.

Back

physical capital accumulation, economic growth

Front

Graph modeling crowding out?

Back

loanable funds market

Front

Increase in government deficit spending raises loan demand and real interest rates. If interest rates rise, investment ______, leading to private capital accumulation ______ in the long run.

Back

decreases, decrease

Front

Loanable funds market's effect on money demand market?

Back

Yes

Answer explanation

The money demand market is impacted by nominal interest rates = real interest + expected inflation.

Assume we increase the demand for loans. r ^, so AD ^, so inflation also goes up, so i ^.

This relationship also clearly shows that investment decreases becuase interest and investment are inversely related.

Front

Government borrowing increases demand for loanable funds. Does this imply increased demand for private sectors?

Back

Not necessarily; demand can be split into public and private sector curves.

Front

Government borrowing increases demand for loanable funds. Effect on loans for private sector?

Back

Surplus: more loans than borrowers.

Answer explanation

Shortages and surpluses always refer to the supply-side point of view. If there is more supply - it's a surplus. If there is less supply, it's a shortage.

Front

Crowding out's impact on government spending?

Back

Yes, it depends on the overall effect of crowding out.