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Crowding out effect of Keynes AP Macroeconomics Mr.PelkeyMarch 2015

Step1:To stimulate aggregate demand, the government will cut taxes . . .

. . .Or increase government spending, to do this government will run a deficit.

STEP 2: Deficit spending -The government spends more money than it takes in from tax revenue

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Step:3 To fund the deficit, the government sell bonds

Step 4:To sell the bonds , the government must lower the bond price which raises the interest rates

Step 5:The rising of interest rates (r) leads to an increase in Interest rates in the private bond market and an increase in interest rates for bank loans!

The demand by government for loans through the bond market pushes out the demand for money and raises interest rates (r)The increase in interest rates makes it more difficult for businesses and consumers to borrow money and buy goods and services . . .

This is called the Crowding out effect of Keynes. Keynes in trying to increase aggregate demand actually pushes out private spending which causes a decrease in C and I. two components of aggregate demand