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


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.


'The Crowding Out Effect' have 2 comments

  1. September 20, 2011 @ 3:03 pm Khageswar Rao K

    THE EXPLANATION IS VERY LUCID!

    Reply

  2. May 9, 2013 @ 1:08 pm Want to Help the Economy? Reduce Pentagon Spending | Coalition to Reduce SpendingCoalition to Reduce Spending

    […] hearken back to the crowding-out effect argument in many areas. This study shows that there is reason to believe this phenomenon exists in […]

    Reply


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