Q. Which one of the following best describes the 'Crowding Out Effect' in the context of fiscal policy?
(a) A situation where private investment increases due to increased Government spending
(b) A situation where Government borrowing leads to higher interest rates, which reduces private investment
(c) A situation where an increase in taxes leads to increased private sector investment
(d) A situation where Government spending has no impact on aggregate demand

Answer : B

Explanation:

When the government increases spending and borrows heavily from the market to finance its fiscal deficit, it competes with private borrowers for available funds. This excess demand for funds pushes up interest rates, making borrowing more expensive for private firms, thereby reducing private investment. This phenomenon is called the Crowding Out Effect.

Source: NCERT — Macroeconomics, Class XII, Chapter 5 — "Government Budget and the Economy"