Crowding out

how government spending increases

1. increasing tax 2. increasing borrowing

financial crowding out

If the government needs to sell more securities, it may have to increase interest rates on its bonds to attract people to buy. Therefore, the increased government borrowing was at the expense of higher interest rates on government debt. These higher interest rates on bonds lead to higher interest rates elsewhere in the economy and are likely to discourage private sector investment and spending.

resource crowding out diagram

PPF diagram, government spending increase, private sector spending falls

crowd out

when government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment

resource crowding out

when the private sector lends money to the government they have less money to invest in private sector projects Furthermore, it is argued that the private sector investment tends to be more efficient than the public sector investment. Therefore, the economy is worse off for government borrowing.

Impacts of higher government spending on aggregate demand

1. Increasing tax--increasing indirect and direct tax on consumers will lead to lower consumer spending. Therefore, higher government spending financed by higher tax should not increase overall AD because the rise in G (government spending) is offset by a fall in C (consumer spending). 2. Increasing borrowing-- to finance borrowing, the government sell bonds to the private sector. This could be private individuals, pension funds or investment trusts. If the private sector buys these government securities they will not be able to use this money to fund private sector investment.