Crowding out is an economic concept that describes a situation where government spending and borrowing reduces overall private sector consumption and investment. Crowding out can be caused by an expansionary fiscal policy financed by increased taxes, borrowing or both.
Crowding out can refer to when government borrowing absorbs all the available lending capacity in the economy. This causes interest rates to rise. As a result, private businesses and individuals find it cost prohibitive to borrow money to fund growth and expansion. This, in turn, can create a downturn in the economy, which lowers tax revenue and thus increases the need for the government to borrow even more money.
Crowding out can also refer to the government conducting activities that were traditionally performed by the private sector. For instance, an increase in government investment and grants to private businesses crowds out the financial entities, such as venture capital firms, that traditionally do this, themselves.
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