Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
It enhances their ability to lend to the private sector.
B
It reduces their lending capacity by increasing government borrowing.
C
It has no impact on their operations during a monetary expansion.
D
It only affects equity markets and not the loanable funds market.
Understanding the Answer
Let's break down why this is correct
Answer
The crowding out effect happens when increased government borrowing leads to higher interest rates, making it more expensive for businesses and individuals to borrow money. In the context of expansionary monetary policy, where the central bank lowers interest rates to encourage borrowing and spending, financial intermediaries like banks play a crucial role. They help channel funds from savers to borrowers, but if the government borrows heavily, it can absorb a lot of the available money in the market. For example, if the government issues bonds to fund a new project, banks might invest in those bonds instead of lending to small businesses. This means that even though the government wants to stimulate the economy, the high demand for loans from the government can limit the funds available for private investment, reducing the overall effectiveness of the monetary policy.
Detailed Explanation
When the government borrows a lot of money, it takes away funds that banks could lend to others. Other options are incorrect because Some might think that more government borrowing helps banks lend more; It's a common mistake to think that government actions don't affect banks.
Key Concepts
crowding out effect
financial intermediaries
effects of monetary policy
Topic
Loanable Funds Market Dynamics
Difficulty
hard level question
Cognitive Level
understand
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