Given below are two statements : one is labelled as Assertion (A) and the other is labelled as Reason (R). Assertion (A) : Deficit spending by the government leads to crowding out effect on private investment. Reason (R) : When the government finances its deficit by borrowing from the market, the bond prices go up and the rate of interest falls. In the light of the above statements, choose the most appropriate answer from the options given below :
Analysis of Assertion (A): Deficit Spending and Crowding Out
Assertion (A) states that deficit spending by the government leads to a crowding out effect on private investment. This is a standard concept in macroeconomics. When a government spends more than its revenue, it often borrows money from the financial markets. This increased government borrowing competes with private sector borrowing, potentially driving up interest rates. Higher interest rates make it more expensive for businesses to borrow funds for investment, thus "crowding out" private investment.
Therefore, Assertion (A) is considered correct.
Analysis of Reason (R): Government Borrowing and Interest Rates
Reason (R) states that when the government finances its deficit by borrowing, bond prices rise, and the rate of interest falls. This is contrary to standard economic theory.
- Increased government borrowing means a higher supply of government bonds.
- To sell these additional bonds, the government must offer them at a lower price or a higher interest rate.
- Bond prices and interest rates have an inverse relationship: as bond prices fall, interest rates rise.
- Therefore, increased government borrowing typically leads to lower bond prices and higher interest rates, not the other way around.
Reason (R) is incorrect because it misstates the relationship between government borrowing, bond prices, and interest rates.
Conclusion
Since Assertion (A) is correct and Reason (R) is incorrect, the most appropriate answer is that (A) is correct but (R) is not correct.
This aligns with Option 3.
Important Questions from Macroeconomics
- A less elastic IS curve means that :
- In Keynesian framework, at full employment, which of the following is/are true ?
(a) Supply curve in the short period is inelastic.
(b) The supply is influenced by the increase in the quantity of money.
Select the answer from the code given below : - When LM curve is vertical, which one of the following is correct ? An increase in money supply will lead to :
- Crowding out will emerge in the economy, if :
- Which among the following were neglected by Keynes in his theory of employment ?
