What is crowding out effect?


I googled it but I have a pretty limited knowledge of economics and Im still not fully understanding the concept. I know it has to do with interest rates going up and the private sector being harmed, but I just dont get how this happens.

For exemple, one definition I found was that government issues bonds to people and that this causes interest rates to go up, which leads to less investments. Why does the government issuing bonds cause an increase in the interest rate? Again, im no expert in econ/finance, so please explain like im 5 or 4 even.

In: Economics

Think of interest rates as the cost of borrowing money – if you want to borrow from someone, interest is what you have to pay for it. So if you have a lot of demand for borrowing and little supply, interest rates are going to go up.

The idea of crowding out is that if you have a government that wants to borrow a lot of money, its demand for money will raise interest rates and make it harder for private companies to borrow. This might be concerning if the government wants to borrow money for wasteful purposes and makes it more expensive for companies to borrow for productive purposes

Economics all comes down to supply and demand. The higher the demand, the higher the price (read: interest when talking money).

If a large government such as e.g. the US government starts borrowing large amounts of money on the market the demand for lending increases. The supply doesn’t increase at the same rate, so the interest rates go up.

If private individuals or companies want to borrow money they have to borrow that on that same market. If interest rates go up an increasing number of investments become economically unattractive because the finding costs outweigh the expected profits. Therefore private spending declines. Private parties are crowding out of a market. The capital market in this example.