History

• FDR's fast-acting decrees averted the crowding out effect during the Great Depression
  
  The Great Depression that plagued America during the 1930s is logically where the beginnings of the modern crowding out effect seeped into the economic lexicon of the government. Though there were risks involved, the federal government was fairly secure in its decision to borrow vast sums of money without fear of crowding out private investors, state and local governments that were too financially destitute to seek loans in the first place.
  Through Franklin Roosevelt's bold executive moves, such as the institution of social security and the Federal Deposit Insurance Corporation (FDIC), the economy was resuscitated rather than further damaged, but then again, there were many stars aligned in FDR's favor. For one thing, the economy was not inextricably linked to other nations at this stage in history. The success of his bravado can also be attributed to the desperation of Americans, which made them more willing to accept such bold measures, not to mention the advent of World War II, a travesty for Europe and a form of CPR for breathing new life into production and assembly line jobs in America.
  
  

Significance

• The IMF is an institution based entirely on loans
  
  The next major attempt to thwart the onset of the crowding out effect was during the Reagan presidency in the 1980s. Reagan's free support of supply side economics was intended to roll back restrictions on free trade and competition, an executive decision laden with somewhat naive brazenness and made in the hope that this would actually increase private investments. This firm attachment to what would become known as voodoo economics did not garner the effects that the Reagan administration was striving to implement.
  Instead of stimulating private investment that would have theoretically created more jobs, hence an economic boom, investors were fairly smug about the tax breaks that were being thrown their way and proved the trickle down theory to be just that--a theory. The 1980s would be the decade to set a new precedent for an almost inverse form of crowding out, wherein private investors had the upper hand and the U.S. government plunged recklessly into an unheard of amount of debt.
  
  

Effects

• The balance between government borrowing and private investment is ever-changing
  
  According to the macroeconomic school of thinking, crowding out, or the borrowing of vast sums of money on the part of the national government, does not produce enough high yield results to make this practice worth the financial risk. The government's heavy borrowing activity generates higher interest rates, thus the demand for loans increases and bolsters the cost of said loans.
  All of this leads to a domino effect, tumbling all the way down to the private sector, which is the entity most egregiously affected by crowding out. Its vulnerability to high interest rates decreases private sector investment, an unavoidable fact that is counterproductive to the government's initial intent to curb recession or stagflation.
  
  

Considerations

• The World Bank makes loans almost solely toward the non-private sector
  
  In crowding out private investors, economic productivity tends to take a rather immediate downturn as government spending is rarely aimed at construction of new factories, production of new consumer products, or the propensity for creating jobs. Granted, there are certain private investors given financial incentive by the government (i.e. Boeing with its defense contracts), but the ultimate goal of government borrowing is to maintain the status quo of the economy rather than actually stimulate further growth. The fatal flaw to the supposed solution of borrowing is that it only accounts for the short-term results and ignores the more than likely potential of augmenting the national deficit.
  
  

Prevention/Solution

• When a government crowds out private investment simply to fund more irresponsible spending habits, it does not just affect that particular country anymore. Now that we live in an age when financial markets are hopelessly interconnected, the gamble of employing behavior that will trigger the crowding out effect is no longer economically viable. While many economists still speculate about the validity of the crowding out theory, the best solution to eschewing its ramifications is for governments of every nation to start managing budgets as though they were tangible and stop looking at them from the perspective of a society dependent upon borrowing, loans and using credit.