CFA Practice Question

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CFA Practice Question

Which one of the following best explains why the crowding-out effect, brought on by an increase in government spending financed by the sale of government bonds to the public, is likely to reduce aggregate demand?
A. The sale of government bonds to the public reduces the money supply and will offset the expansionary impact of increased government spending.
B. The sale of government bonds to the public will drive up interest rates, thereby retarding private investment and aggregate demand.
C. This question is based on a false premise. The crowding-out effect suggests that the government's selling of bonds to the public is a very effective tool with which to stimulate demand.

User Contributed Comments 7

User Comment
tenny45 Isn't the sale of gov bonds to public a RESTRICTIVE monetary policy, therefore it would lead to an increase (SURPLUS) budget, LOWERING the interst rate?
danlan The sale of gov bonds is a restrictive monetary policy. But it leads to budget deficit (as gov borrows money from national people), thus drive up interest rates and retarding private investment and aggregate demand. B is right.
octavianus Sale of government bonds to the public is performed by the Treasury Department, not the Federal Reserve.

Thus, it is not monetary policy (carried out by the Federal Reserve) and does not effect the money supply.

It does however increase demand for loanable funds, drives up interest rates, and thus reduces consumption and investment.
StanleyMo yeap, is fiscal policy
smmahmood thnx. need to watch out for whose policy is this..the Fed or the treasury?
cmacewen The sale of government bonds is not an open market operation - it's simply the government acquiring more debt. By adding to the supply of debt in the market, interest rates must increase to equilibrate supply and demand.
yugeng769 crowd-out effect
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