Crowding Out
The reduction in private sector investment caused by increased government borrowing.
What is Crowding Out?
Crowding out occurs when increased government borrowing to finance a budget deficit raises interest rates, making it more expensive for private businesses and individuals to borrow. As a result, private investment falls, partially or fully offsetting the stimulative effect of the government spending. The mechanism: when the government issues more bonds, the increased supply of debt drives up yields (interest rates), competing with private borrowers for available savings. Critics of large deficit spending argue crowding out reduces the net economic benefit. Proponents argue crowding out is minimal when the economy has slack — when there is idle capital, the government borrowing does not genuinely compete with private demand.
Example
In the early 1980s, the US ran large budget deficits while the Federal Reserve kept interest rates high to fight inflation. The resulting high real interest rates (Treasury yields above 10%) were cited by economists as crowding out private business investment, contributing to the deep 1981–82 recession.
Source: CBO — Macroeconomic Effects of Alternative Fiscal Policies