If crowding-out occurs, what is the typical direction of private investment?

• A. Increase
• B. Decrease
• C. No change
• D. Uncertain

Answer: (B)

When the government borrows more to finance a deficit, it increases the demand for loanable funds. This tends to push up interest rates. Higher borrowing costs make private investment projects less attractive, so private investment falls on average. That’s why the typical direction is a decrease in private investment.

Increase would require lower borrowing costs or other forces offsetting the higher demand for funds, which isn’t the standard result. No change doesn’t reflect the interaction in the loanable funds market, and while evidence can vary in practice, the usual model shows a decline.