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Crowding Out Effect

Increased government borrowing raises market interest rates, making it difficult for corporations and individuals to afford borrowing. This "crowding out effect" occurs when growing government debt displaces private companies and people from credit markets. While government spending aims to boost the economy in the short-run, crowding out limits this stimulus as higher interest rates reduce private investment more than the initial increase in public spending under the multiplier effect.

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Mazhar Mughal
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2K views2 pages

Crowding Out Effect

Increased government borrowing raises market interest rates, making it difficult for corporations and individuals to afford borrowing. This "crowding out effect" occurs when growing government debt displaces private companies and people from credit markets. While government spending aims to boost the economy in the short-run, crowding out limits this stimulus as higher interest rates reduce private investment more than the initial increase in public spending under the multiplier effect.

Uploaded by

Mazhar Mughal
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd

Crowding out Effect

Increased government borrowing tends to increase market interest


rates. The problem is that the government can always pay the market
interest rate, but there comes a point when corporations and
individuals can no longer afford to borrow.

The problem occurs when government debt 'crowds out' private


companies and individuals from the lending market.

The implication of crowding out effects is that the effect of


government spending to stimulate economy in short-run by increasing
in short run does not give the full benefit as expected by the
phenomenon of multiplier effect.

In the graph above the wants to rise its GDP from Yo to Y1 through
the borrowing and multiplier effect.
Due to the crowding out effect the government would not be able to
achieve the Y1 level, the level of growth which would achieved is Ye
(shown with the green line).

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