Crowding Out Effect

The crowding out effect occurs when increased government spending leads to a decrease in private sector investment. When the government borrows money to fund its programs, it can raise interest rates because there’s more competition for available funds. Higher interest rates make it more expensive for businesses and individuals to borrow, which can discourage them from making investments. As a result, the government’s efforts to stimulate the economy may unintentionally limit private investment, counteracting the intended benefits of its spending. This can affect overall economic growth and the effectiveness of fiscal policy.