Question
UPSC Prelims 2026 Question:
Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy?
Answer (Detailed Solution Below)
Option 2: A situation where Government borrowing leads to higher interest rates, which reduces private investment
Detailed Solution
Answer: 2Â
Explanation:Â Â
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.Â
- 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, âcrowding outâ 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.Â
Therefore, option (2) is the correct answer
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Last updated on July, 2026
