What is 'crowding out' and does it really happen?

'Crowding out' is a mainstream economic theory that claims government borrowing competes with private borrowing for a limited pool of savings, driving up interest rates and reducing private investment. It's often cited as a reason to limit government deficits.

MMT economists argue that crowding out doesn't work the way mainstream theory suggests, for several reasons.

First, the premise is flawed. The theory assumes there's a fixed pool of savings that government and private sector must compete for. But the government doesn't borrow in the conventional sense - it creates the currency. Government spending actually adds to private sector savings and bank reserves, creating more funds available for lending, not fewer.

Second, empirically it hasn't happened. Japan has run large deficits for decades with interest rates near zero. The US ran enormous deficits during and after the 2008 financial crisis, yet interest rates remained low. The predicted crowding out didn't materialize.

Third, the central bank controls interest rates. If the Federal Reserve wants to keep rates low, it can, regardless of deficit levels. Japan demonstrates this clearly - despite debt-to-GDP ratios over 200%, rates have been near zero for years.

What can happen is 'crowding out' of real resources - if the government hires workers and purchases materials when the economy is at full capacity, fewer resources are available for private use. But this is about real constraints, not financial ones.