CROWDING OUT OF PRIVATE INVESTMENT

CROWDING OUT OF PRIVATE INVESTMENT

TOPIC: Economy

Context- Public borrowing won’t crowd out private investment: Finance Minister Nirmala Sitharaman urged industry to step up investments and expand capacities, asserting that worries about high public capital spending and borrowings crowding out private investments were misplaced.

Concept-

Crowding out effect:

• A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect.
• In other words, when the government is increasing its expenditure, private expenditure comes down.
• Sometimes, government adopts an expansionary fiscal policy stance and increases its spending to boost the economic activity.
• This leads to an increase in interest rates. Increased interest rates affect private investment decisions.
• With higher interest rates, the cost for funds to be invested increases and affects their accessibility to debt financing mechanisms. This leads to lesser investment ultimately and crowds out the impact of the initial rise in the total investment spending. Usually the initial increase in government spending is funded using higher taxes or borrowing on part of the government.
• Some believe that government spending does not always lead to a crowding out of private investment in the economy. They instead argue that government demand for funds can compensate for the lack of private demand for funds during economic depressions, thus helping to prop up aggregate demand.