In January, the interest rate is 5 percent and firms borrow $ 50 billion per month for investment projects. In February, the federal governmnet doubles its monthly borrowing from $ 25 billion to $ 50 billion. That drives the interest rate up to 7 percent. As a result, firms cut back  their borrowing to only $ 30 billion per month. Which of the following is true? A). There is no crowding-out effect because the government's increase in borrowing exceeds firms' decrease in borrowing. B) There is a crowding-out effect of $20 billion. C) There is a crowding-out effect of $ 25 billion. D). There is no crowding-out effect because both the government and firms are still borrowing a lot.

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Asked Nov 4, 2019
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In January, the interest rate is 5 percent and firms borrow $ 50 billion per month for investment projects. In February, the federal governmnet doubles its monthly borrowing from $ 25 billion to $ 50 billion. That drives the interest rate up to 7 percent. As a result, firms cut back  their borrowing to only $ 30 billion per month. 

Which of the following is true? 

A). There is no crowding-out effect because the government's increase in borrowing exceeds firms' decrease in borrowing. 

B) There is a crowding-out effect of $20 billion. 

C) There is a crowding-out effect of $ 25 billion. 

D). There is no crowding-out effect because both the government and firms are still borrowing a lot. 

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Expert Answer

Step 1

Crowding out effect is a scenario in which a increase in the interest rate leads to a fall in the investment spending by the private sector such that it reduces the initial increase in the total investment spending.

In this ca...

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