ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The crowding out effect theory suggests that rising public sector spending drives down private sector spending. To spend more, the government needs more revenue, which it gets through higher taxes and/or sales of Treasuries. This can reduce private sector income and loan demand, thus decreasing spending and borrowing.

Detailed explanation-2: -The government spending is “crowding out” investment because it is demanding more loanable funds and thus causing increased interest rates and therefore reducing investment spending. This basic analysis has been broadened to multiple channels that might leave total output little changed or even smaller.

Detailed explanation-3: -The economic crowding-out effect refers to increased government borrowing and spending causing a reduction in private spending. Because government borrowing increases the cost of private loans and uses up capital that may have been deployed elsewhere, businesses and individuals don’t borrow or spend as much money.

Detailed explanation-4: -The government deficit is associated with an increase in long-term interest rates. Any effort toward lowering the expected level of future national savings places upward pressure on expected short-term interest rates.

Detailed explanation-5: -Definition: A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect.