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Definition:

  • Crowding Out occurs when the U.S government increases its borrowing from the Loanable Funds Market in order to support its Fiscal policies or pay back interest on the national debt. 

Short term effect:

  • When the government increases borrowing, there are less funds for private sector investors to borrow, thus increasing the real interest rate as a result of the demand curve shifting to the right. 
  • This results in a decrease in the quantity of funds demanded by investors. Both of these graphs are shown below: 

Long term effect:

  • In the long-run, this results in a decreased rate of economic growth as investors are left with less funds to buy capital and produce more goods and services.

Photo: “Crowding Out.” Crowding out Theory - Effects of Expansion of Public Sector | Economics Online, www.economicsonline.co.uk/Managing_the_economy/Crowding_out.html.

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