What is the primary effect of government borrowing in the context of fiscal policy?

The primary effect of government borrowing in the context of fiscal policy is that it crowds out private sector borrowing. When a government borrows money, typically by issuing bonds, it competes for funds in the financial markets. As the government raises its demand for loans, interest rates may rise because lenders have a limited supply of funds to lend. Higher interest rates can lead to increased borrowing costs for businesses and individuals, which may deter them from taking loans for investment or consumption.

As a consequence, when the government borrows heavily, it can result in reduced private sector investment since businesses might either choose not to borrow at higher rates or may find it financially unfeasible to do so. This effect is particularly significant in an economy where savings are fixed or limited, making it harder for private entities to secure funding for growth or expansion. Consequently, while the government may aim to stimulate the economy through its spending, the crowding out effect can counteract these benefits by stifling private investment.