According to the crowding-out effect, if the government runs a budget deficit of $100 billion, what is the change in the equilibrium quantity of investment?
What will be an ideal response?
Investment decreases. The government budget deficit increases the demand for loanable funds and, as a result, the real interest rate rises. The increase in the real interest rate decreases the quantity of investment. However, the decrease in investment is less than $100 billion because the higher real interest rate also increases the quantity of private saving.
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