In economics, crowding out theoretically occurs when the government expands its borrowing to finance increased expenditure, or cuts taxes (i.e. is engaged in deficit spending), crowding out private sector investment by way of higher interest rates. To the extent that there is controversy in modern Macroeconomics on the subject, it is because of disagreements about how financial markets would react to more government borrowing. This article or section does not cite its references or sources. ... Circulation in macroeconomics Macroeconomics is a branch of Economics that deals with the performance, structure, and behavior of the economy as a whole. ...

If increased borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher "price" (ceteris paribus), the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out. The weakening of fixed investment and other interest-sensitive expenditure counteracts to varying extents the expansionary effect of government deficits. More importantly, a fall in fixed investment by business can hurt long-term economic growth of the supply side, i.e., the growth of potential output. Ceteris paribus is a Latin phrase, literally translated as with other things [being] the same, and usually rendered in English as all other things being equal. ... The private sector of a nations economy consists of all that is outside the state. ... In economics, potential output (also referred to as natural real gross domestic product) refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. ...

However, this crowding-out effect is moderated by the fact that government spending expands the market for private-sector products through the multiplier and thus stimulates – or "crowds in" – fixed investment (via the "accelerator effect"). This accelerator effect is most important when business suffers from unused industrial capacity, i.e., during a serious recession or a depression. The accelerator effect in economics refers to a positive effect on private fixed investment of the growth of the market economy (measured e. ... In macroeconomics, the definition of recession is a decline in any countrys Gross Domestic Product (GDP), or negative real economic growth, for two or more successive quarters of a year. ... WORLD OF WARCRAFT IS THE BEST GAME EVER INVENTED AND PLAY IT. IF YOU DONT PLAY WORLD OF WARCRAFT, YOU ARE A nOOb. ...

Crowding out can, in principle, be avoided if the deficit is financed by simply printing money, but this carries concerns of accelerating inflation.

Crowding out of another sort may occur due to the prevalence of floating exchange rates, as demonstrated by the Mundell-Fleming model. Government borrowing leads to higher interest rates, which attract inflows of money on the capital account from foreign financial markets into the domestic currency (i.e., into assets denominated in that currency). Under floating exchange rates, that leads to appreciation of the exchange rate and thus the "crowding out" of domestic exports (which become more expensive to those using foreign currency). This counteracts the demand-promoting effects of government deficits but has no obvious negative effect on long-term economic growth. The Mundell-Fleming model is an economic model first set forth by Robert Mundell and Marcus Fleming. ... The capital account is one of two primary components of the balance of payments. ... Appreciation is a term used in accounting relating to the increase in value of an asset. ...

In the United States during the late 1990s, another kind of crowding out of exports occurred: large increases in private fixed investment and consumer spending encouraged high interest rates, a high dollar exchange rate, and hurt exports.

Crowding out is most serious when an economy is already at potential output or full employment. Then the government's expansionary fiscal policy encourages increased prices, which lead to an increased demand for money. This in turn leads to higher interest rates (ceteris paribus) and crowds out interest-sensitive spending. At potential output, businesses are in no need of markets, so that there is no room for an accelerator effect. More directly, if the economy stays at full employment gross domestic product, any increase in government purchases shifts resources away the private sector. This phenomenon is sometimes called "real" crowding out. In economics, potential output (also referred to as natural real gross domestic product) refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. ... In economics, full employment has more than one meaning. ... Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. ... For other uses, see Money (disambiguation). ... Nominal GDP per person (capita) in 2006. ...

The negative effects on long-term economic growth that occur when private fixed investment are crowded out can be moderated if the government uses its deficit to finance productive investment in education, basic research, and the like. The situation is made worse, of course, if the government wastes borrowed money.

See also

Motivation crowding theory The Motivation crowding theory suggests that external interventions - monetary incentives or punishments - may undermine (and under different conditions strengthen) intrinsic motivation. ...

References

• Roger W. Spencer & William P. Yohe, "The 'Crowding Out' of Private Expenditures by Fiscal Policy Actions", Federal Reserve Bank of St. Louis Review, October 1970, pp. 12-24 for an earlier review of the literature.