Question

UPSC Prelims 2026 Question:

Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy?

1. A situation where private investment increases due to increased Government spending
2. A situation where Government borrowing leads to higher interest rates, which reduces private investment
3. A situation where an increase in taxes leads to increased private sector investment
4. A situation where Government spending has no impact on aggregate demand

Answer (Detailed Solution Below)

Option 2: A situation where Government borrowing leads to higher interest rates, which reduces private investment

Detailed Solution

Answer: 2

Explanation:

The crowding out effect refers to the decrease in private sector investment due to increased government borrowing and spending, which can raise interest rates and reduce available capital.

The theory of crowding out contrasts with crowding in, where government spending during economic downturns can stimulate private sector activity.
According to the crowding in theory, government borrowing during periods of low economic activity can increase demand, generate employment, and stimulate private spending and investment. This helps revive economic growth. In contrast, “crowding out” occurs when excessive government borrowing raises interest rates and reduces the availability of funds for the private sector. Higher borrowing costs and taxes may reduce private investment, spending, and overall economic activity, making crowding out generally harmful for growth.

Therefore, option (2) is the correct answer

Latest UPSC Exam 2026 Updates

Last updated on June, 2026

→ UPSC Prelims Result 2026 is now out.

→ UPSC IFoS Prelims Result 2026 is now out.

→ Enroll in Vajiram & Ravi’s UPSC Mains Test Series 2026 for structured answer writing practice, expert evaluation, and exam-oriented feedback.

→ Join Vajiram & Ravi’s UPSC Mentorship Program 2026 for personalized guidance, strategy planning, and one-to-one support from experienced mentors.

→ Join Vajiram & Ravi’s UPSC Mentorship Program 2027 for personalized guidance, strategy planning, and one-to-one support from experienced mentors.

→ UPSC Prelims Provisional Answer Key 2026 out for GS Paper 1 and CSAT.

→ UPSC Prelims Question Paper 2026 Out, Download GS Paper 1 PDF conducted on 24th May 2026.

→ UPSC Mains 2026 will be conducted from 21st August 2026 onwards, and UPSC Prelims 2027 will be held on 23rd May 2027.

→ UPSC Final Result 2025 is now out.

→ UPSC has released UPSC Toppers List 2025 with the Civil Services final result on its official website.

→ Anuj Agnihotri secured AIR 1 in the UPSC Civil Services Examination 2025.

→ UPSC Notification 2026 & UPSC IFoS Notification 2026 is now out on the official website at upsconline.nic.in.

→ UPSC Calendar 2027 has been released.

→ Check out the latest UPSC Syllabus 2026 here.

→ The UPSC Selection Process is of 3 stages-Prelims, Mains and Interview.

→ Shakti Dubey secures AIR 1 in UPSC CSE Exam 2024.

→ Also check Best UPSC Coaching in India

Tags: upsc prelims 2026 upsc prelims 2026 questions

Vajiram Content Team

At Vajiram & Ravi, our team includes subject experts who have appeared for the UPSC Mains and the Interview stage. With their deep understanding of the exam, they create content that is clear, to the point, reliable, and helpful for aspirants.Their aim is to make even difficult topics easy to understand and directly useful for your UPSC preparation—whether it’s for Current Affairs, General Studies, or Optional subjects. Every note, article, or test is designed to save your time and boost your performance.