Crowding Out Effect

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DEFINITION of 'Crowding Out Effect'

An economic concept where increased public sector spending replaces, or drives down, private sector spending. Crowding out refers to when government must finance its spending with taxes and/or with deficit spending, leaving businesses with less money and effectively "crowding them out." One explanation of why crowding out occurs is government financing of projects with deficit spending through the use of borrowed money. Because the government borrows such large amounts of capital, its activities can increase interest rates. Higher interest rates discourage individuals and businesses from borrowing money, which reduces their spending and investment activities.

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BREAKING DOWN 'Crowding Out Effect'

For example, the higher taxes required for government to fund social welfare programs leaves less discretionary income for individuals and businesses to make charitable donations. Further, when government funds certain activities there is little incentive for businesses and individuals to spend on those same things. Another example is increased government spending on Medicaid, which has been linked to decreased availability of private health insurance.

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RELATED FAQS
  1. How does crowding out affect supply and demand in the private-sector?

    Crowding out decreases private-sector demand because the higher government borrowing causes an equivalent fall in private ... Read Full Answer >>
  2. How does the crowding out effect influence the multiplier effect of a government ...

    In traditional economic theory, the crowding-out effect, to whatever extent it occurs, reduces the multiplier effect of deficit-funded ... Read Full Answer >>
  3. Do budget deficits "crowd out" the market?

    Government deficits crowd out private investment, although the mechanism through which that occurs can be more or less direct. ... Read Full Answer >>
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    Fiscal deficit describes a government with expenditures that are greater than its revenues during a fiscal year. The federal ... Read Full Answer >>
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