FANDOM


The "crowding out" effect is the reduction in private consumption and investment when the government increases spending and is an example of demand-side policy that actually hurts aggregate demand. When the government decides to increase spending and not increase taxes, it has to borrow money from somewhere. This means that the demand for money in the loanable funds market will increase, shifting the demand curve to the right. When demand shifts to the right, both the "price" (in this case the real interest rate) and the quantity of loans increases. When the real interest rate increases, it becomes harder for other people to borrow money and the amount of private spending in the economy will decrease. This is why it's called "crowding out" - government spending crowds out private spending.

When people decide to not spend as much money as they did before the effect, aggregate demand gets pushed to the left at the same time that it should be going to the right because of the increase in government spending. However, it is difficult to quantitatively say how much the increase in loans to the government actually affects private spending. The "crowding out" effect is a good thing to be aware of but it is not particularly effective in predicting how the market will actually turn out.

Ad blocker interference detected!


Wikia is a free-to-use site that makes money from advertising. We have a modified experience for viewers using ad blockers

Wikia is not accessible if you’ve made further modifications. Remove the custom ad blocker rule(s) and the page will load as expected.