Crowding Out
AP Macroeconomics
What is the "Crowding Out Effect"?
The crowding out effect is an economic theory stipulating that rises in public sector spending drive down or even eliminate private sector spending. Though the “crowding out effect” is a general term, it is often used in reference to the stifling of private spending in areas where government purchasing is high.
The crowding out effect is also often referred to simply as “crowding out.”
Because “crowding out” is a general term, most cases of crowding out share some important similarities, but there are a few distinct ways in which crowding out can happen.
One of the most common forms of crowding out takes place when a large government, like that of the United States, increases its borrowing. Because large governments have the power to borrow large sums of money, doing so can actually have a substantial impact on the real interest rate, raising it by a significant degree. This has the effect of absorbing the economy’s lending capacity and of discouraging businesses from engaging in capital projects. Because firms often fund such projects in part or entirely through financing, they are now discouraged from doing so because the opportunity cost of borrowing money has risen, making traditionally profitable projects funded through loans cost-prohibitive.
From: http://www.investopedia.com/terms/c/crowdingouteffect.asp#ixzz46Djiv8wg