5.5 Crowding Out
Crowding out: government deficit borrowing raises the real interest rate in the loanable funds market, which reduces private investment spending.
When the government runs a deficit, it borrows in the loanable funds market. Show it either way the CED allows: demand for loanable funds shifts right (the government is a new borrower) or the supply shifts left (public dissaving reduces national saving). Both raise the equilibrium REAL interest rate.
The higher real rate makes some private projects unprofitable, so private investment — and interest-sensitive consumption — falls. That is the crowding out: government borrowing displaces private spending, partially offsetting the fiscal stimulus.
The long-run cost is slower growth: less investment today means a smaller capital stock tomorrow, so LRAS shifts right more slowly. FRQs typically ask for the loanable funds graph, the real-rate direction, and the investment consequence in sequence.
Key terms for 5.5
Drag the curves yourself — the fastest way to make 5.5 stick.
Drawing crowding out in the money market. Government borrowing works through the LOANABLE FUNDS market and the real interest rate — the Fed hasn't changed the money supply.
Get AP Econ exam tips in your inbox
Occasional emails with study tips, new interactive graphs, and exam-season reminders. Free — no spam.
No spam. Unsubscribe anytime.