What is crowding out in economics?

Crowding out refers to a phenomenon in which increased government borrowing reduces the amount of private investment in the economy. When the government borrows more, it competes for available funds in the financial markets. This increased demand for funds can lead to higher interest rates, making it more expensive for private sector entities to borrow money. As a result, businesses may postpone or reduce their investment projects, as financing becomes less accessible or more costly. Thus, the reduction in private investment is a direct consequence of government actions in the borrowing sector, diminishing the overall investment capacity of the economy.

This concept highlights the trade-offs between government spending and private sector investment, illustrating how fiscal policy can influence economic dynamics. While the government may aim to stimulate the economy through increased spending, the unintended effect may be a contraction in private investment, which can have long-term implications for economic growth.