Question

Suppose the government increases spending without changing taxes in an effort to shift the aggregate demand curve to the right, thereby increasing both real GDP and the price level. If the central bank responds to the increase in prices by raising interest rates, the central bank policy will result in ___________ in private investment spending. This is also known as the ________ effect.

Answer 1

decrease

crowding out effect

Step-by-step explanation:

Crowding out effect determined the impact of government spending either on the supply side or demand side.

Due to spending increased by the government, prices are raised and real interest rate is charged. Investment is one of the function of real interest rate, but increase in the interest rate causes the decrease in the investment value. This decrease in the investment is known as the crowding effect.