crowding out
Imagine there is only so much savings in the economy available to be lent out — a limited pool of money looking for somewhere to go. Now the government decides to borrow heavily to fund a big spending program. It dips into that same pool, competing with private companies who also want to borrow to build factories or buy equipment. With more demand for the limited savings, the price of borrowing — the interest rate — gets bid up, and some private firms, facing higher costs, decide not to invest. The government's borrowing has 'crowded out' private investment. That displacement is crowding out.
More precisely, crowding out is the reduction in private spending (especially business investment) caused by an increase in government borrowing or spending. The classic channel works through interest rates: government deficits raise the demand for loanable funds, pushing rates up, which discourages interest-sensitive private spending like investment and home-building. A numeric feel: if a 100 billion stimulus is partly offset by, say, 40 billion of private investment that no longer happens because rates rose, the net boost to the economy is only 60 billion — the multiplier is dragged down. There is also 'resource crowding out': in a fully employed economy, if the government hires the workers and buys the steel, those resources are simply unavailable to the private sector.
Crowding out is the central argument against deficit-financed government spending, and how much it actually happens is hotly debated. The key insight is that it depends on the state of the economy. When the economy is at full employment and savings are scarce, crowding out is strong — extra government borrowing genuinely competes for limited resources. But in a deep recession, with idle workers, idle factories, and savers desperate for somewhere safe to park money (and the central bank holding rates low), there is plenty of slack, so government borrowing need not raise rates much and crowding out can be small or absent. The opposite can even occur — 'crowding in' — if public investment makes private investment more attractive.
If a government borrows heavily during a boom, interest rates climb, and a company that would have borrowed to build a new plant cancels it because financing now costs too much. The factory that never gets built is the crowded-out private investment — the hidden cost of the government's borrowing.
Government borrowing competes for the same savings firms need — pushing up rates and squeezing private investment.
Crowding out is strong at full employment but can be weak or absent in a deep recession with idle resources and low rates — which is why its real-world size is contested.