How can a high fiscal deficit lead to crowding out in the economy?
Show answer & explanation
Correct answer: C
Explanation
The correct answer is Option 3 i.e. By leading to higher interest rates and reduced private investment.
A high fiscal deficit can lead to crowding out by raising interest rates and reducing private investment. When the government borrows heavily to finance its deficit, the demand for credit in the market increases. This higher demand pushes up interest rates, making loans more expensive for businesses and individuals. As a result, private investors may cut back on borrowing and investments. Thus, instead of boosting overall growth, excessive government borrowing can reduce private sector participation, limiting long-term economic development despite short-term demand benefits.