What is the Crowding Out Effect?

The crowding out effect describes the idea that large volumes of government borrowing push up the real interest rate, making it difficult or close to impossible for individuals and small companies to obtain loans.

How Does the Crowding Out Effect Work?

The theory behind the crowding out effect assumes that governmental borrowing uses up a larger and larger proportion of the total supply of savings available for investment. Because demand for savings increases while supply stays the same, the price of money (the interest rate) goes up.

Crowding out begins to take effect when the interest rate level reaches a point at which only the government can afford to borrow. Unable to compete for loans under such circumstances, individuals and smaller-scale companies are forced (crowded) out of the market.

Why Does the Crowding Out Effect Matter?

Because crowding out leads to decreases in private sector consumption and, therefore, slows economic growth, the crowding out effect should be a serious consideration for any government that plans to get an increasing percentage of its funding through the capital markets.

[In its efforts to stimulate the economy, the U.S. government is accumulating trillions and trillions in national debt. A debt that size will likely never be repaid without causing a massive decline in the purchasing power of the U.S. dollar.]

Ask an Expert about Crowding Out Effect

All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Crowding Out Effect.

Be the first to ask a question

If you have a question about Crowding Out Effect, then please ask Paul.

Ask a question
Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

Verified Content You Can Trust
verified   Certified Expertsverified   5,000+ Research Pagesverified   5+ Million Users