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    • Thread Starter

    Some economists argue that an expansionary fiscal policy - increased government spending, lower taxation adversely effects the economy for the following reasons:

    Argument 1 -
    Expansionary fiscal policy reduces investment spending by the private sector.
    The increased borrowing 'crowds out' private investing. ----
    WHY would the increased borrowing 'crowd' out private investing????

    Argument 2 -
    Government spending provides a good or service that would otherwise be provided by the private sector, and be subject only to the economic forces in voluntary exchange.

    I understand argument 2, but fail to understand 1.

    Presumably argument 1 means increased borrowing by the government as a consequence of an expansionary fiscal policy filters through to increased interest rates? Or what?

    The argument would be that if there is a fixed amount of loanable funds, government borrowing is competing for those funds with private sector firms that want to borrow, so it drives up the interest rate and reduces private sector investment.
    • Community Assistant

    Community Assistant
    Have a look at this:

    Does crowding out occur? Expansionary fiscal policy involves higher spending and more government borrowing; it could cause crowding. This means that although the government spend more because they borrow from private sector, the private sector have less to spend and invest. Therefore, overall AD doesn’t increase.

    The government often finances its spending by borrowing. When it borrows, investors buy bonds, whereas they could have invested in more productive assets like machnes and robots. Spending is crowded out from productive investments and into bonds.

    it is argued that private firms are more efficient at spending than the government. It would be more beneficial for the private sector to increase. Essentially what it means that as the government invests there is less opportunity for private firms, who can achieve more.
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