UPSC Prelims 2026
Question 59 of 100
59
Question 59
GS Paper-1 • 2 Marks
Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy ?

Options

A
a) A situation where private investment increases due to increased Government spending
B
b) A situation where Government borrowing leads to higher interest rates, which reduces private investment
Correct Answer
C
c) A situation where an increase in taxes leads to increased private sector investment
D
d) A situation where Government spending has no impact on aggregate demand

📖Detailed Explanation

Answer: (b)

Explanation:
The crowding out effect in fiscal policy occurs when increased government borrowing (to finance higher public spending or fiscal deficits) raises demand for loanable funds in the economy. This leads to higher interest rates, which in turn discourages or reduces private sector investment because borrowing becomes more expensive.

In simple terms, government borrowing "crowds out" private investment by competing for the same pool of financial resources.
59 / 100

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