Explain the concept of crowding out in the context of government borrowing from the central bank.

Explain the concept of crowding out in the context of government borrowing from the central bank.

Crowding out refers to the phenomenon where increased government borrowing from the central bank leads to a decrease in private sector borrowing and investment. When the government borrows from the central bank, it increases the demand for loanable funds, which in turn raises interest rates. Higher interest rates make it more expensive for businesses and individuals to borrow money, reducing their ability and willingness to invest and spend. As a result, private sector investment and consumption are "crowded out" by the government's increased borrowing, leading to a decrease in overall economic activity.