What is the term for the phenomenon where increased government borrowing leads to higher interest rates and reduces private borrowing?

• A. Crowding-out effect
• B. Inflationary pressure
• C. Liquidity preference
• D. Supply-side improvement

Answer: (A)

The central idea is that when the government borrows more, it increases the demand for loanable funds. This higher demand pushes up interest rates, making borrowing more expensive for private borrowers and leading them to cut back on private investment and borrowing. That reduction in private activity driven by higher rates is called the crowding-out effect—the government’s financing needs crowding out private sector borrowing.

Keep in mind that the strength of this effect depends on the economy’s context. In some cases, if there’s slack or if monetary policy accommodates higher rates, crowding out can be modest. The other terms don’t describe this process: inflationary pressure is about rising prices, liquidity preference is about the demand for money, and a supply-side improvement refers to gains in productive capacity.