CFA Practice Question

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CFA Practice Question

The crowding-out effect implies that an expansionary fiscal policy will have the following result(s):

I. higher real interest rate
II. higher nominal interest rate
III. higher dollar value in the foreign exchange market
IV. increased net exports
A. II and IV
B. II and III
C. I and III
Explanation: The real interest rate will be higher, since the government borrowing will increase the demand for loanable funds. The nominal interest rate will be determined by both the real rate AND the inflation rate, and it's uncertain that it will be higher. The higher real interest rate will attract financial capital from abroad and lead to an appreciation of the dollar, which in turn will reduce the net exports.

User Contributed Comments 5

User Comment
danlan Nominal interest rate will be higher also since real interest rate will be higher and inflation rate will be higher.
smillis danlan: It is not clear that inflation will be higher.
tom1980 since crowding out effect will cause the decline in consmer spending and investment resulting from the incease of the real interest rate, thus offsetting the initial increae in aggregate demand by the expansionary fiscal policy, and therefore, price level might increae or decrease.
NickPash I Agree somewhat with Danlan, Since Nominal Int.Rate includes real int rate and Inflation. Nominal is higher as well even if inflation is near zero which is almost never. I guess there is a chance of deflation during recession.
gill15 Thats why this question is on the difficult side.

You guys are not taking into account Crowding Out --- Crowding out reduces private spending. Although we have an expansionary policy the reduces private spending counters this and we dont know what happens to price level. Only Real interest rate is affected.
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