IB Economics Higher Level (HL) 2025 – 400 Free Practice Questions to Pass the Exam

The scenario described in the question refers to a situation where government expenditures surpass its revenues, necessitating borrowing, which can indeed lead to higher interest rates. The correct and most relevant answer in this context is deficit spending.

Deficit spending occurs when a government intentionally decides to spend more money than it generates in revenue, typically through taxes. This approach often requires financing through borrowing, which can result in increased demand for credit in the economy. When the government borrows heavily to cover budget deficits, it can lead to higher interest rates as the supply of loanable funds decreases, making borrowing more expensive for consumers and businesses.

This situation can have broader economic implications, including the potential to crowd out private investment, as businesses may find it more costly to borrow due to elevated interest rates caused by government borrowing.

While "crowding out" refers to the specific consequence of deficit spending on private investments, it does not address the initial action of a government borrowing to finance a deficit. The other options do not accurately capture the essence of government spending beyond its income in this specific context. Thus, deficit spending effectively describes the situation highlighted in the question.