Question

The increase in private investment spending induced by the increase in Government spending is known as
1. Crowding in
2. Deficit financing
3. Crowding out
4. Pumping out

Answer 1

Correct Answer - Option 1 : Crowding in

The correct answer is Crowding in​.

• Crowding occurs when higher government spending leads to an increase in private sector investment.
• The crowding in effects occurs because higher government spending leads to an increase in economic growth and therefore encourages firms to invest because there are now more profitable investment opportunities

Difference between crowding out and crowding in:

• When the government pursues expansionary fiscal policy (higher spending financed by borrowing) there are two possible effects
  • Crowding out :
    • higher government spending financed by borrowing leads to a fall in private sector savings.
    • This is for two main reasons.
      • With expansionary fiscal policy, private sector savers buy government bonds and so have fewer savings to fund private sector investment.
      • Also, higher government borrowing tends to push up interest rates and these higher interest rates reduce investment.
  • Crowding in:
    • This relates to how higher government spending encourages firms to invest more. This is due to the income effect of higher government spending.
    • If the economy is in a recession or below full capacity, expansionary fiscal policy can increase the economic growth rate and create a positive multiplier effect, which leads to greater private sector investment.