Critics of discretionary fiscal policies argue that increased government spending may have little effect on real output. The reason is that crowding-out effects may dampen the stimulus to aggregate demand arising from the additional government spending. What is a crowding- out effect? Using an IS-LM diagram, explain how this occurs. In light of your explanation, why does the crowding-out effect become stronger when money demand becomes less sensitive to the interest rate?

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A crowdingout effect occurs when increased government spending leads to higher interest rates which ... View the full answer