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Crowding out effect

Wondering if someone could help me understand crowding out effect; I had understood it as a function of expansionary fiscal policy (increased government spending) which crowded out private investment. I got a question wrong on CFA, which said that crowding out effect is associated with increasing government borrowing

Looking at Schweser I see the following two explanations: 

“ Increased government borrowing will tend to increase interest rates, and firms may reduce their borrowing and investment spending as a result, decreasing the impact on aggregate demand of deficit spending. This is referred to as the crowding-out effect.”

“Crowding-out effect: Expansionary fiscal policy may crowd out private investment, reducing the impact on aggregate demand.”

In my mind, these lines are saying two different things: One says expansionary fiscal policy causes it (which would be increased government spending, not borrowing) and one says increased government borrowing causes it (which would be contractionary fiscal policy no?)

Any insight is much appreciated. 

sas525 wrote:

One says expansionary fiscal policy causes it (which would be increased government spending, not borrowing) and one says increased government borrowing causes it (which would be contractionary fiscal policy no?)

I think you have them a little confused. If the government is employing expansionary fiscal policies, then it’s likely borrowing a good deal of those funds being spent. And as you correctly pointed out, more government borrowing increases the costs of borrowing, which in turn makes private investment increasingly expensive/less attractive. 

Hope that helps!

"Between stimulus and response there is a space. In that space is our power to choose our response. In our response lies our growth and our freedom." -Viktor Frankl

If the government is employing expansionary fiscal policies (increasing gov expenditures), would this not decrease interest rates as it is increasing the money supply? I guess my thoughts are, why is the government borrowing having a larger economic effect than the government spending?

Thank you for the help. Actually had thought I had this fiscal/monetary policy understanding down pretty tight. Also shoutout Lakers if your name is referencing Kobe. 

I ran into that problem you’re talking about. I think it has to do with the fact that in order for government to spend, it must borrlow (sell more bonds).