Question

Crowding out occurs when

A. governments must borrow funds which causes interest rates to rise and thus private investment is reduced.
B. interest rates increase as firms spend a larger amount of resources on research and development.
C. interest rates increase because the Federal Reserve reduces that​ economy's money supply.
D. firms borrow more to expand operations which results in an increase in interest rates.

Answer 1

A. governments must borrow funds which causes interest rates to rise and thus private investment is reduced.

Step-by-step explanation:

Crowding out is an economic concept that aims to explain the side effect of rising interest rates, which nullifies the effects of rising government spending, which should stimulate the economy.

To increase spending, the government must finance itself with more taxes, or by issuing more government bonds, raising interest rates to attract new investors. The crowding out effect happens when the increase in government interest rates influences the other interest rates in the country, so as to make private investments more expensive, totally or partially canceling the economic expansion. This affects private investment and the economy as a whole. Consequently, the government is experiencing an increase in the fiscal deficit without the positive effects of government spending generating economic expansion. Thus, the economy is in a worse situation.