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How does the crowding out effect work?

Posted on April 14, 2014 at 6:10 PM

The crowding out effect is an unintended consequence of expansionary fiscal policy. When the government increases spending, it borrows from the loanable funds market causing real interest rates to rise. The increase in interest rates causes households and businesses to cut back on spending. This means that consumption and gross investment is "crowded out" by the expansionary fiscal policy that caused real interest rates to rise.

The heavy metal music video below explains everything that you need to know about the crowding out effect in the short run and the long run.

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AP Macroeconomics Unit 5 Macroeconomic Theory

Categories: AP Macroeconomics, Macro Unit 5 Macroeconomic Theory

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