In economics, crowding out is a phenomenon that occurs when increased government involvement in a sector of the market economy substantially affects the remainder of the market, either on the supply or demand side of the market. One type frequently discussed is when expansionary fiscal policy reduces investment spending by the private sector. The government spending is "crowding out" investment because it is demanding more loanable funds and thus causing increased interest rates and therefore reducing investment spending. This basic analysis has been broadened to multiple channels that might leave total output little changed or even smaller. Other economists use "crowding out" to refer to government providing a service or good that would otherwise be a business opportunity for private industry, and be subject only to the economic forces seen in voluntary exchange. Behavioral economists and other social scientists also use "crowding out" to describe a downside of solutions based on private exchange: the crowding out of intrinsic motivation and prosocial norms in response to the financial incentives of voluntary market exchange. ## [Crowing out sources](https://en.wikipedia.org/wiki/Crowding_out_(economics)) If increased borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher "price" ([[ceteris paribus]]), the private sector, which is sensitive to interest rates, will likely reduce investment due to a lower rate of return. This is the investment that is crowded out. The weakening of fixed investment and other interest-sensitive expenditure counteracts to varying extents the expansionary effect of government deficits. More importantly, a fall in fixed investment by business can hurt long-term economic growth of the supply side, i.e., the growth of potential output. Thus, the situation in which borrowing may lead to crowding out is that companies would like to expand productive capacity, but, because of high interest rates, cannot borrow funds with which to do so. According to American economist Jared Bernstein, writing in 2011, this scenario is "not a plausible story with excess capacity, the Fed funds [interest] rate at zero, and companies sitting on cash that they could invest with if they saw good reasons to do so." Another American economist, Paul Krugman, pointed out that, after the beginning of the recession in 2008, the federal government's borrowing increased by hundreds of billions of dollars, leading to warnings about crowding out, but instead interest rates had actually fallen. When aggregate demand is low, government spending tends to expand the market for private-sector products through the fiscal multiplier and thus stimulates – or "crowds in" – fixed investment (via the "accelerator effect"). This accelerator effect is most important when business suffers from unused industrial capacity, i.e., during a serious recession or a depression. Crowding out can, in principle, be avoided if the deficit is financed by simply printing money, but this carries concerns of accelerating inflation. Chartalist and Post-Keynesian economists question the crowding out thesis because government bonds sales have the actual effect of lowering short-term interest rates, not raising them, since the rate for short-term debt is always set by central banks. Additionally, private credit is not constrained by any "amount of funds" or "money supply" or similar concept. Rather, banks lend to any credit-worthy customer, constrained by their capitalization level and risk regulations. The resulting loan creates a deposit simultaneously, increasing the amount of endogenous money at that time. Crowding out is most plausibly effective when an economy is already at potential output or full employment. Then the government's expansionary fiscal policy encourages increased prices, which lead to an increased demand for money. This in turn leads to higher interest rates (ceteris paribus) and crowds out interest-sensitive spending. At potential output, businesses are in no need of markets, so that there is no room for an accelerator effect. More directly, if the economy stays at full employment gross domestic product, any increase in government purchases shifts resources away from the private sector. This phenomenon is sometimes called "real" crowding out. Crowding out of another sort (often referred to as international crowding out) may occur due to the prevalence of floating exchange rates, as demonstrated by the Mundell–Fleming model. Government borrowing leads to higher interest rates, which attract inflows of money on the capital account from foreign financial markets into the domestic currency (i.e., into assets denominated in that currency). Under floating exchange rates, that leads to appreciation of the exchange rate and thus the "crowding out" of domestic exports (which become more expensive to those using foreign currency). This counteracts the demand-promoting effects of government deficits but has no obvious negative effect on long-term economic growth.