Question

If the MPC were about 0.75 on average, this would imply a government spending multiplier of about 4, according to the simple formula used in introductory courses. However, real world estimates of the spending multiplier in the US are often in the (wide) range of 0.5 to 2.25. What is a frequently cited reason why the measured spending multiplier is lower than what the simple formula would predict

Answer 1

Answer: b. crowding out

Step-by-step explanation:

Crowing out occurs when the government borrows money to spend on the economy. When this happens, the supply of loanable funds decreases which would lead to an increase in interest rates which hampers investment as entities would not want a high cost of borrowing.

Even through therefore, there is an increase in government spending, companies might not take advantage as they do not want to incur increased borrowing costs so the economy would not grow as much as predicted by the simple formula which does not account for the effects of crowding out.