5.5: Crowding Out

What model would we use to describe crowding out?

Loanable funds market

What change in the loanable funds market does crowding out come from?

An increase in the demand for loanable funds

When government increases deficit spending…

• Demand for loanable funds ^

• Real IR ^

• Total quantity of loans ^

• Private quanity of loans ^

  • Private sector borrows less

  • less capital accumulation

  • slower economic growth

  • LRAS ←

Pie analogy

More public sector loans eats more of the pie and leaves less for private sector.

Crowding out

The adverse effect of borrowing on interest-sensitive private sector spending

Government tries to finance its debt by

selling bonds

When government does debt management policy, it’s goal is to

minimize the cost of borrowing