The Crowding-Out Effect
| English | Chinese | Pinyin |
|---|---|---|
| loanable funds | 可贷资金 | kě dài zī jīn |
| crowding out | 挤出效应 | jǐ chū xiào yìng |
| real interest rate | 实际利率 | shí jì lì lǜ |
| private investment | 私人投资 | sī rén tóu zī |
Two borrowers, one pool of savings
- Firms borrow to invest; the government borrows to fund a deficit.
- They draw from the same pool — the market for loanable funds 可贷资金.
- When the government borrows a lot, it competes with firms for those savings.
- The result has a name: crowding out 挤出效应.
Firms and the government both borrow from the market for:
The loanable-funds market channels savings to borrowers.
Government deficit spending shifts the demand for loanable funds:
More borrowing demand at each rate shifts demand right and raises the rate.
How the interest rate rises
- Government deficit spending raises the demand for loanable funds — the demand curve shifts right.
- More borrowers chasing the same savings pushes the real interest rate 实际利率 up.
- Draw it in the loanable-funds market: demand right → the equilibrium real rate climbs.
Higher rates cut private investment from 400 to 360. By how much did investment fall?
400 − 360 = 40 crowded out.
When higher rates reduce private investment, we say it has been ______ out.
The government "crowds out" private borrowers by pushing up the rate.
Why private investment falls
- A higher real interest rate makes borrowing more expensive for firms.
- So private investment 私人投资 falls — the government has crowded it out.
- Worked idea. Government borrowing pushes the real rate from $3\%$ to $5\%$. Firms cut investment from $400$ to $360$ — a fall of $40$.
- This weakens the boost that the deficit spending was meant to give.
Crowding out is strongest when the economy is:
Scarce savings mean extra government borrowing bids the rate up sharply.
Crowding out makes expansionary fiscal policy partly self-defeating.
Some of the demand boost is cancelled by lost private investment.
The bottom line for fiscal policy
- Crowding out means expansionary fiscal policy is partly self-defeating: some private spending is lost.
- It is strongest when the economy is near full employment (savings are scarce).
- It is weakest in a deep recession (idle savings, rates barely move).
- So the timing of deficit spending matters — a recession, not a boom, is when it crowds out least.
The crowding-out effect
Follow how extra government borrowing can push out private investment.
Crowding out: government borrowing raises the demand for loanable funds, pushing the real interest rate up (e.g. $3\% \to 5\%$), which lowers private investment ($400 \to 360$). It makes expansionary fiscal policy partly self-defeating, and is strongest near full employment.