AuthorTopic: Crowding out effect?
cocacola
@2018-03-27 19:39:46
Crowding out effects mention that goverment deficit reduces private investment because of the increase in real interest rate.

And here i am thinking why?

if interest rate is high(doesn't matter nominal or real), we would like to invest our savings, as it would be more than the opportunity cost of our consumption. and now here this crowding effect mentions that an inrecase in real interest rate decrease private investment, decrease quantity of loanable funds. Can anybody give me a logical explanation please. I would be really great.
rockstar1
@2018-04-01 23:41:46
A very simple and logical way of looking at this would be:

Govt. has a deficit, so it borrows money from banks, then there would be a lower quantity of loanable funds, and thus, interest rates would go up ( nominal or real), higher interest rates would discourage prospective investors to invest money as there borrowing costs would go up.
debby
@2018-05-07 13:22:10
Just to add to what rockstar1 said:

The government must borrow from the loanable funds market to finance the deficit. Higher government borrowing lowers the supply of loanable funds available for the private sector. This decrease in supply results in higher interest rates, that cause investment to fall.

Basically, private investment gets 'crowded out' by high government borrowing.

CFA Discussion Topic: Crowding out effect?

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I used your notes and passed ... highly recommended!
Lauren

Lauren