Definition

Crowding out is an economics-related theory that states that increases in the public sector-related spending eliminate or even drive down the spending in the private sector. Crowding out is a general term, but it refers to situations in which government spending stifles private spending. As a result of increased borrowings and taxes, a fiscal expansion can cause crowding out.

Brief Explanation of Crowding out

It most commonly takes place when borrowings from a large government increase. Since a large government possesses the capability to borrow a huge amount of money it substantially impacts the real interest rate by raising it significantly. Due to this, the lending capacity of the economy is absorbed and businesses get discouraged to engage in capital projects. Organizations usually finance capital projects through loans, which makes conventionally profitable projects unfeasible now due to rising opportunity costs.