1. What is the crowding - out effect? example?2. Why were those who took out hybrid loans at far...

Question

1. What is the crowding - out effect? example?
2. Why were those who took out hybrid loans at far greater risk of foreclosure when the Fed began raising interest rates?
3. How are each of the following events likely to affect the value of the dollar relative to the euro?
a. Interest rates in the European Union increases relative to those in the United States.
b. The European Union price level rises relative to the U.S. price level.
c. The European central bank intervenes by selling dollars on currency markets.
d. The price level in the United States falls relative to the price level in Europe.

Robert · Accepted Answer

1) Suppose, the government increases government increases government expenditure. This 
would increase the aggregate demand and hence national income (Y) at a constant rate of 
interest. This increase in Y will increase the transaction demand for money. [We know, 
Money demand = Md = m(Y) + m(r)]. But money supply is fixed. Hence there will be 
disequilibrium in the money market. To restore the equilibrium, demand for money must 
go down. Hence, speculative demand for money must do down for which rate of 
interest(r) must go up. But as r rises, investment falls, due to which Y falls a little. This 
fall in Y is known as crowding out effect. Thus crowding out effect decreases the size of 
the private sector.

1. What is the crowding - out effect? example? 2. Why were those who took out hybrid loans at far greater risk of foreclosure when the Fed began raising interest rates? 3. How are each of the...

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