Can someone explain the crowding-out effect (Budget deficit caused by expansionary fiscal policy reduces the impact of the expansionary fiscal policy on aggregate demand)?
maratikus, What really happens is …… When the government has to undertake some spending (freeway construction, public parks, etc), it issues bonds and starts borrowing in the market. As the demand for borrowing increases, the Interest Rates increase… The government can borrow at virtually any prevailing interest rate but there comes a point where borrowing becomes too expensive for corporations (to borrow at the prevailing market interest rate) so they begin to what we call as ‘Crowd-out’ and hence the silly name to this effect ‘Crowding-Effect’. - Dinesh S
thanks, dinesh.sundrani!