Crowding out

effect of
Keynes
AP Macroeconomics
Mr.Pelkey
March 2015

Step1:To stimulate
aggregate demand, the
government will cut taxes .
..

. . .Or increase
government
spending, to do
this
government will
run a deficit.

STEP 2: Deficit spending -The

government spends more money
than it takes in from tax revenue

Step:3 To fund the

deficit, the
government sell
bonds

Step 4:To sell

the bonds ,
the government
must lower
the bond
price which

Step 5:The rising

of interest rates (r)
leads to an increase
in Interest rates in
the private bond
market and an
increase in interest
rates for bank loans!

The increase in
interest rates
makes it more
difficult for
businesses and
consumers to
borrow money
and buy goods
and services . . .

The demand by government for loans through the bond

market pushes out the demand for money and raises
interest rates (r)

This is called the

Crowding out
effect of Keynes.
Keynes in trying to
increase aggregate demand
actually pushes out private
spending which causes a
decrease in C and I. two
components of aggregate
demand