The contraction of private investment spending due to deficit spending by the Government is called
- (a)crowding out
- (b)crowding in
- (c)pump priming
- (d)dumping
Correct — A, crowding out. When a government runs a deficit it must borrow, and that borrowing competes with private borrowers for the same pool of savings. The extra demand for loanable funds pushes the interest rate up, dearer credit makes some private projects no longer worth financing, and private investment spending contracts. Economists call that squeezing-out of private investment by public borrowing the crowding-out effect, and the phrase is exactly what the stem defines.
- (b)crowding in — The opposite effect and a real one. If public spending goes into infrastructure that makes private projects more profitable, or if it lifts demand in a slack economy, private investment rises alongside public spending rather than falling.
- (c)pump priming — Names the government's action rather than its side effect. Pump priming is a modest injection of public spending intended to restart private demand in a downturn, in the hope that the economy then keeps going on its own.
- (d)dumping — Belongs to trade rather than to public finance. Dumping is selling exports in a foreign market below normal value or below cost, and it is met with anti-dumping duties, not with monetary policy.
Crowding out is the standard argument against large and persistent fiscal deficits. Savings available for investment in an economy are finite in the short run, so government borrowing to finance a deficit takes a share of them, raises the interest rate, and deters private investment. How much crowding out actually occurs is debated and depends on the state of the economy: when resources are idle and demand is weak, public spending can raise incomes and savings enough that private investment is not squeezed at all, and may even be encouraged. That happier outcome is crowding in.
The four options are best learned as a set, because CDS has asked for more than one of them and each is a term a student is likely to have met without pinning down. Two of them are opposite sides of the same fiscal question, one names a policy rather than an effect, and one comes from a different chapter altogether. The sentence in the stem contains its own signal: contraction of private investment, caused by government deficit spending, is by definition the crowding-out story. Worth noting that crowding out is also the channel by which fiscal policy raises the interest rate in the previous question's policy mix, so the two items are the domestic and the external face of a single mechanism.
- Crowding out is the fall in private investment caused by government borrowing raising the interest rate.
- Crowding in is the opposite — public spending that raises the profitability of private projects and lifts private investment with it.
- Pump priming is a limited public spending injection meant to revive private demand in a slowdown.
- Dumping is a trade practice, the export of goods below normal value, countered by anti-dumping duties.
- How far crowding out actually bites depends on how much spare capacity the economy has.
The mechanism runs through the interest rate; if the deficit does not raise it, private investment is not squeezed.
- Mixing up crowding out with crowding in, since the two differ by a single word.
- Treating pump priming as an effect when it is a deliberate policy.
- Importing dumping from trade policy into a public-finance question.
As a name-the-term item in either direction, or as a statements item on the effects of a persistent fiscal deficit.
With reference to the Indian Public Finance consider the following statements: 1. External liabilities reported in Union Budget are based on historical exchange rates. 2. The continued high borrowing has kept the real interest rates high in the economy. 3. The upward trend in the ratio of Fiscal Deficit to GDP in recent years has an adverse effect to private investments. 4. Interest payments is the single largest component of the non-plan expenditure of the Union Government. Which of the above statements are correct?
- (a) 1, 2 and 3
- (b) 1 and 4
- (c) 2, 3 and 4
- (d) 1, 2, 3 and 4
Answer(c) 2, 3 and 4
The same effect described rather than named. Two of the accepted statements there are the two links of this chain — heavy government borrowing keeping real interest rates high, and a rising deficit ratio harming private investment.
CDS_GK_2021_I_Q42021The increase in private investment spending induced by the increase in Government spending is known as
- (a) Crowding in
- (b) Deficit financing
- (c) Crowding out
- (d) Pumping out
Answer(a) Crowding in
The exact mirror of this item from two years earlier, with the same two terms offered against each other. CDS has now asked the pair in both directions, which makes learning them together the efficient move.
- practice — not a real PYQ
The rise in private investment spending induced by an increase in government expenditure is known as
- (a)crowding out
- (b)crowding in
- (c)deficit financing
- (d)monetisation of the deficit
Answer(b) crowding in — public spending that raises demand or improves infrastructure can make private projects more attractive rather than squeezing them out.
- practice — not a real PYQ
Crowding out is usually said to operate through which one of the following channels?
- (a)A fall in the exchange rate
- (b)A rise in the interest rate
- (c)A rise in the unemployment rate
- (d)A fall in the tax-to-GDP ratio
Answer(b) A rise in the interest rate — government borrowing competes for savings, credit becomes dearer, and private investment is deterred.