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Answer :
The statement is true; crowding out can weaken the effectiveness of demand-side fiscal policy by increasing interest rates and reducing private investment, while the opposite effect, crowding in, may occur with contractionary fiscal policy. However, the extent of crowding out or crowding in is still debated among economists.
The statement regarding the impact of crowding out on the effectiveness of demand-side fiscal policy is indeed true. Crowding out weakens the impact of fiscal policy because it may lead to higher interest rates, which in turn reduce private investment and can constrain economic growth.
This occurs when government spending replaces private sector spending in the economy, or when increased government borrowing pushes up interest rates. While some economists argue that crowding out and crowding in can make fiscal policy ineffective, the actual extent to which this occurs is still a topic of debate due to inconclusive empirical studies.
In contrast, crowding in is observed when contractionary fiscal policy, such as cuts in government spending or increases in taxes, may lead to lower interest rates that boost private investment and net exports.
In summary, both crowding out and crowding in clearly weaken the impact of an expansionary and contractionary fiscal policy, respectively, but the overall effect on aggregate demand remains controversial and dependent on the economic context.
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