Final answer:
It is true that higher interest rates from government borrowing to finance a deficit can lead to a smaller impact of expansionary fiscal policy on aggregate demand due to the crowding out effect.
Step-by-step explanation:
It is true that if government borrowing to finance a deficit drives up interest rates, expansionary fiscal policy will have a smaller effect on aggregate demand (AD) than expected. An expansionary fiscal policy aims to increase AD through tax cuts or spending increases.
However, if this policy leads to higher interest rates, it can discourage borrowing and spending by firms and households, similar to the effects of tight monetary policy.
This phenomenon is referred to as crowding out, where government borrowing results in higher interest rates that, in turn, reduce business investment and household consumption, yielding a less powerful fiscal stimulus than initially anticipated.