In the classical model, the escalation in government spending is funded by issuing bonds to the public. This action elevates interest rates within the economy, leading to more expensive loans.
What happens in the classical economy as government spends more
Consequently, overall investment in the economy declines. This is a phenomenon recognized as the crowding-out effect. Despite the surge in government expenditure, aggregate demand remains stagnant.
Government's heightened financing necessitates more funds in the loanable fund market, causing the demand curve for loanable funds to shift right while the supply curve remains constant.