Canadian Securities Course (CSC) Level 1 Practice Exam

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What is crowding out in relation to government borrowing?

Government spending increases to stimulate the economy
Government borrows significantly, reducing available capital for businesses
Government decreases spending to curb inflation
Government collects taxes to fund public projects

The correct answer is: Government borrows significantly, reducing available capital for businesses

Crowding out refers to a situation where increased government borrowing leads to a reduction in the amount of capital available for private sector investment. When the government borrows extensively, it competes for financial resources in the capital markets. This competition can drive up interest rates as lenders have a limited supply of capital to lend. As interest rates rise, borrowing becomes more expensive for businesses and individuals, which can lead to a decrease in private sector spending and investment. In this context, option B accurately captures the essence of crowding out, illustrating how significant government borrowing can limit the availability of funds for businesses. This phenomenon can hinder economic growth as businesses may delay or scale back expansion plans due to higher costs of borrowing. The other options focus on different aspects of government fiscal policy but do not specifically address the implications of borrowing on the availability of capital for the private sector, which is central to understanding crowding out.