Crowding - the price level, also has a similar effect on...

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Crowding-out effect: Keynes' fiscal policies of expansion and contraction have been popular with modern public authorities. These policies have been used effectively over the past years in many economies the world over. However, modern followers of the classical school, also known as monetarists , point out the faults of such fiscal measures. It is pointed out that extra government expenditure is financed through public borrowings . As a result of this, the money available for loans is reduced and there is a greater demand for loanable funds in the money and capital markets. With a sudden rise in the demand the price of loanable funds or the rate of interest starts rising . Again extra public expenditure, which gives rise to an upward movement of
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Unformatted text preview: the price level, also has a similar effect on the rate of interest. Rising level of the interest rate has a discouraging effect on private investment activity. Thus increased public investment expenditure causes a fall in the private investment activity. This is called the 'crowding-out' effect. It is claimed therefore that fiscal policy is likely to develop a self-defeating tendency . On the other hand, during the phase of inflation, contraction in public expenditure can be equally self-defeating. In this case with a fall in the effective demand, the rate of interest will tend to fall and will encourage private investment activity. This is exactly the opposite case and therefore can be called the 'crowding-in' effect....
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This note was uploaded on 11/17/2011 for the course EC ec 201 taught by Professor - during the Fall '10 term at Montgomery.

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