RAS question
Crowding out effect in economics refers to:
Correct answer: (C) Government borrowing reducing private sector investment by raising interest rates.
In economics, the crowding out effect means government borrowing or deficit spending reduces private sector investment by pushing up interest rates.
Explanation
Crowding out links public borrowing with private investment through the interest-rate channel. When government borrowing is high, interest rates rise, making borrowing costlier for private firms and reducing their investment. eGyanKosh, Unit 14: Sources of Public Debt describes the same mechanism: crowding out occurs when government expands borrowing to finance expenditure or deficit spending, and private sector investment is crowded out through higher interest rates. The fall in fixed investment and other interest-sensitive spending can offset part of the expansionary effect of fiscal deficits. That is why option C captures the economic idea precisely: the issue is not simply higher government spending, but its displacement of private investment via dearer credit.
Why the other options are wrong
- (A) Exports reducing domestic supply describes an external trade effect on availability, not a fall in private investment caused by government borrowing and higher interest rates.
- (B) Large firms eliminating small firms points to monopolisation or market structure, whereas crowding out is about public borrowing competing for funds and reducing private investment.
- (D) Foreign companies replacing domestic firms is market competition or displacement by foreign entrants, not the interest-rate effect of government borrowing on private investment.
Concept
This tests fiscal policy and public debt, especially how deficit financing can affect private investment through interest rates. It recurs in RAS because fiscal deficit, public borrowing and investment are core Indian Economy linkages.