What Factors Determine How Much Crowding Out Takes Place?
The extent to which interest rate adjustments dampen the output expansion induced by increased government spending is determined by:
- Income increases more, interest rates increase less, the flatter LM (Liquidity preference—Money supply) curve.
- Income increases less, interest rates increase less, the flatter IS (Investment—Saving) curve.
- Income and interest rates increase more the larger the multiplier, thus, the larger the horizontal shift in the IS curve.
In each case, the extent of crowding out is greater the more interest rate increases when government spending rises.
Read more about this topic: Crowding Out (economics)
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