What is Crowding out ?
Definition of Crowding out
Crowding out is an economics related theory which states that increases in public sector related spending eliminate or even drive down the spending in private sector. Although “crowding out effect” is a generalized term, but mostly used in situations where the private spending is stifled because of rise in government purchasing. An expansionary fiscal policy can cause crowding out which was financed by increased borrowings and taxes.
Brief Explanation of Crowding out
It is most commonly takes place when borrowings of a large government increases. Since large government possesses the capability to borrow huge amount of money which substantially impacts the real interest rate by raising it significantly. Due to this, lending capacity of economy is absorbed and businesses get discouraged to engage in capital projects. As organizations mostly fund capital projects entirely or in part through financing, therefore they are not interested to borrow finance now due to the rise in opportunity cost connected to borrowing money, making conventionally profitable projects financed by loan cost-prohibitive.