ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -When governments borrow, they compete with everybody else in the economy who wants to borrow the limited amount of savings available. As a result of this competition, the real interest rate increases and private investment decreases. This is phenomenon is called crowding out.

Detailed explanation-2: -Crowding out and crowding in clearly weaken the impact of fiscal policy. An expansionary fiscal policy has less punch; a contractionary policy puts less of a damper on economic activity. Some economists argue that these forces are so powerful that a change in fiscal policy will have no effect on aggregate demand.

Detailed explanation-3: -According to Post – Keynesian macroeconomics views, in a modern economy operating below capacity, government borrowings can increase demand by generating employment, thereby encouraging private investment, thus leading to crowding-in.

Detailed explanation-4: -The crowding-out effect of expansionary fiscal policy suggests that when the economy is at its full capacity, an increase in additional spending from the public sector causes a decline in the private sector spending. Government spending is financed through raising taxes or borrowings that involve bonds.