Question

The crowding-out effect operates because:

Options

• Consumers fully anticipate future tax liabilities and stop consuming

• The government competes with the private sector for available funds, leaving less for private investment

• Interest payments on debt decline as the debt stock rises

• Foreign lenders withdraw goods from the domestic economy

Answer 1

When the government borrows, it competes with the private sector for available funds. Since savings are limited, this competition leaves less for private investment, which is the mechanism behind crowding out.