POL-3.C—a. Define crowding out. b. Explain (using graphs as appropriate) how fiscal policy may cause crowding out

a. Define crowding out. b. Explain (using graphs as appropriate) how fiscal policy may cause crowding out.

• When a government is in budget deficit, it typically borrows to finance its spending.
• A loanable funds market model can be used to show the effect of government borrowing on the equilibrium real interest rate and the resulting crowding out of private investment. [See MKT-4]
• Crowding out refers to the adverse effect of increased government borrowing, which leads to decreased levels of interest-sensitive private sector spending in the short run.
• A potential long-run impact of crowding out is a lower rate of physical capital accumulation and less economic growth as a result.
• Enduring understanding POL-3: There are long-run implications of monetary and fiscal policy.