AP MacroeconomicsFiscal Policy
Crowding Out
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.
Formula / Example
Higher deficit → ↑ demand for loanable funds → ↑ real interest rate → ↓ private investment.
Interactive graph
Loanable Funds →
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Study module
The Loanable Funds Market →
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