Crowding Out [ECON]

Read "→" as "leads to" in the options below. Which of the following best describes the chain of events in the relationship between deficits and potential output? Choose 1 answer:

Deficit → higher real interest rates → less private investment → smaller capital stock → slower growth of potential output

The nation of Fantastica engaged in borrowing to finance deficit spending. Which of the following would be the most likely impact on the long-run aggregate supply (LRAS) curve in Fantastica?

LRAS decreases (shifts to the left)

A government that has a budget balance enters a recession and decides to engage in expansionary fiscal policy. Which of the following best describes what will most likely happen as a result of the expansionary fiscal policy?

The government runs a budget deficit

An economy has a budget deficit, and you want to show the impact of the budget deficit on the real interest rate. What model would you use, and what would be the impact on the interest rate?

The loanable funds market; real interest rate increases

Which model would be used to show the impact of government deficit spending on the real interest rate?

The market for loanable funds

The government of Burginville has run a deficit of $20 million which it intends to pay for by issuing new government bonds. What impact will this action have on the bond market and the market for loanable funds?

The supply of bonds in the bond market increases; the demand for funds in the loanable funds market increases

Under which circumstance is crowding out most likely to be a concern?

When an economy is operating near full employment

What does the term "crowding out" refer to?

When government borrowing increases, private sector investment spending decreases

The economy of Burginville has been running budget deficits which it paid for by borrowing. What is the likely impact of government borrowing on spending on capital goods and economic growth in Burginville?

A decrease in spending on capital goods; a decrease in economic growth

Which of the following is the most likely long-run impact of government deficits?

A smaller stock of capital

Which of the following is the most likely way a government will finance deficit spending?

Borrowing

Economic conditions in Fredland have caused the demand for money to increase which has changed the nominal interest rate. If the central bank wants to counteract this change, which of the following is an appropriate open market operation to achieve that?

Buy bonds.