Wondering if someone could help me understand crowding out effect; I had understood it as a function of expansionary fiscal policy (increased government spending) which crowded out private investment. I got a question wrong on CFA, which said that crowding out effect is associated with increasing government borrowing.
Looking at Schweser I see the following two explanations:
" Increased government borrowing will tend to increase interest rates, and firms may reduce their borrowing and investment spending as a result, decreasing the impact on aggregate demand of deficit spending. This is referred to as the crowding-out effect."
"Crowding-out effect: Expansionary fiscal policy may crowd out private investment, reducing the impact on aggregate demand."
In my mind, these lines are saying two different things: One says expansionary fiscal policy causes it (which would be increased government spending, not borrowing) and one says increased government borrowing causes it (which would be contractionary fiscal policy no?)
I think you have them a little confused. If the government is employing expansionary fiscal policies, then it’s likely borrowing a good deal of those funds being spent. And as you correctly pointed out, more government borrowing increases the costs of borrowing, which in turn makes private investment increasingly expensive/less attractive.
If the government is employing expansionary fiscal policies (increasing gov expenditures), would this not decrease interest rates as it is increasing the money supply? I guess my thoughts are, why is the government borrowing having a larger economic effect than the government spending?
Thank you for the help. Actually had thought I had this fiscal/monetary policy understanding down pretty tight. Also shoutout Lakers if your name is referencing Kobe.
I ran into that problem you’re talking about. I think it has to do with the fact that in order for government to spend, it must borrlow (sell more bonds).