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Crowding Out

The crowding out view is that a rapid growth of government spending leads to a transfer of scarce productive resources from the private sector to the public sector where productivity might be lower. It can lead to higher taxes and interest rates which then squeezes profits, investment and employment in the private sector.

Crowding out refers to the phenomenon whereby government borrowing to finance its deficit reduces the availability of credit in the private sector, thereby raising interest rates and reducing private investment.

The crowding out effect occurs when the government increases its borrowing to finance its deficit, thereby increasing the demand for credit in the market. This can lead to higher interest rates, as lenders demand a higher return for the increased risk of lending to the government. Higher interest rates can make it more expensive for businesses and individuals to borrow money, which can reduce private investment and economic activity.

The crowding out effect can be mitigated through the use of various policy tools, such as monetary policy and fiscal policy. For example, the central bank can use monetary policy to keep interest rates low and encourage borrowing, while the government can use fiscal policy to reduce its deficit and decrease its demand for credit.

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