Crowding Out vs Crowding In

Crowding out is the fall in private investment that happens when government borrowing pushes up real interest rates.

When the government runs a deficit it borrows in the loanable funds market, raising the demand for loanable funds and the real interest rate. The higher rate discourages private investment and interest-sensitive spending, partly offsetting the expansionary fiscal policy. It is a key limitation of deficit-financed government spending.

Crowding in is when government spending raises private investment—the opposite of crowding out—typically during a recession with idle resources.

In a deep recession, expansionary fiscal policy can boost demand, output, and incomes without driving up interest rates much, because savings are ample and resources are idle. The resulting rise in sales and optimism encourages firms to invest, so public spending 'crowds in' rather than crowds out private investment. The accelerator effect (higher output raising desired capital) reinforces this. Whether crowding in or crowding out dominates depends on how close the economy is to full employment.