What is the concept of “crowding out” in economics?

Crowding out occurs when increased government spending leads to a reduction in private sector investment. This typically happens when the government borrows money to finance its spending, raising interest rates and making it more expensive for businesses and individuals to borrow. As a result, private investment may decline, as higher borrowing costs discourage businesses from taking on new projects. Crowding out can limit the effectiveness of fiscal policy in stimulating economic growth, particularly if the government’s borrowing leads to higher interest rates that inhibit private sector spending and investment.