The Crowding Out Effect

The Crowding Out effect is a Monetarist criticism of expansionary fiscal policy. As seen in the multiplier effect, government spending will shift Aggregate Demand (AD) further than expected. However, Monetarists believe that because of this expansionary fiscal policy, the government will need to borrow money by selling government bonds. This leads to a rise in interest rates, i.e. from R1 to R3.

Rise in Interest Rate

Rise in Interest Rate

The Crowding Out Effect

A rise in interest rates would discourage private investors from investing and private consumption may also decrease. So the result could be a rise from AD1 to AD2, instead of AD1 to AD3.

The Crowding Out Effect

The Crowding Out Effect


About

Prateek Agarwal loves Economics, so he decided to set up Intelligent Economist as a way to share his passion for Economics with the world. After completing his undergraduate degree in Economics at U.S.C., Prateek is now working in the Healthcare industry.


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