Which factor would increase the likelihood of crowding-out?

Which factor would increase the likelihood of crowding-out?

• A. A booming stock market
• B. A free-trade regime
• C. Very large deficits financed by debt
• D. High private savings

Answer: (C)

Crowding-out happens when the government’s borrowing competes with private borrowers for the same pool of funds, pushing up interest rates and making private investment less attractive. When deficits are very large and financed by debt, the government needs to issue a lot of bonds, increasing the demand for loanable funds. That higher demand tends to raise interest rates, so private firms find it costlier to borrow and may cut back on investment. This effect is stronger when the economy is near full employment, where there aren’t many idle funds, so the crowding-out impact shows up more clearly. Other options don’t push up the demand for loanable funds in the same way; a booming stock market, for example, changes where some private investment goes but doesn’t systematically raise interest rates to crowd out investment. A free-trade regime affects trade and efficiency rather than the funding market directly. Very large deficits financed by debt specifically alter the funding environment to increase crowding-out, while high private savings would supply more loanable funds and reduce it.

Crowding-out happens when the government’s borrowing competes with private borrowers for the same pool of funds, pushing up interest rates and making private investment less attractive. When deficits are very large and financed by debt, the government needs to issue a lot of bonds, increasing the demand for loanable funds. That higher demand tends to raise interest rates, so private firms find it costlier to borrow and may cut back on investment. This effect is stronger when the economy is near full employment, where there aren’t many idle funds, so the crowding-out impact shows up more clearly.

Other options don’t push up the demand for loanable funds in the same way; a booming stock market, for example, changes where some private investment goes but doesn’t systematically raise interest rates to crowd out investment. A free-trade regime affects trade and efficiency rather than the funding market directly. Very large deficits financed by debt specifically alter the funding environment to increase crowding-out, while high private savings would supply more loanable funds and reduce it.