Thus, the increased activity by government crowds-out investment expenditures because of the increased interest rates required to obtain investment capital.
Crowding-out may be partial or it may be complete. A complete crowding-out occurs when the decrease in investment expenditures is equal to the increase in government expenditures. A partial crowding-out occurs when the decrease in investment expenditures is less than the increase in government expenditures.
Over the longer-term, an expansionary fiscal policy has a negative effect on real GDP because the long-range aggregate supply (LRAS) curve does not change. Over the longer-term, and expansionary fiscal policy increases the price level and the short-term aggregate supply (SRAS) curve shifts to the left. Thus, the AD curve intersects the LRAS curve at a point reflecting a higher price level and a lower real GDP.
Keynesian economists hold that (a) the economy is inherently unstable and (b) fiscal policy is more effective than is monetary policy because an expansionary fiscal policy can be structured to minimize the crowding-out of investment expenditures. Monetarist economists reject the Keynesian argument, holding instead that (a) the economy is inherently stable and (b) monetary policy is more stable because fiscal policy always causes too much crowding-out of investment. In part, the disagreement between the Keynesians and the monetarists revolves around the issue of what constitutes "too much crowding-out" of investment expenditures. Keynesians view the issue in relative terms [e.g., complete crowding-out is undesirable, but partial crowding-out is justified when a pressing need exists to stimulate demand quickly]. Monetarists view the issue in black and white terms [e.g., any crowding-out is undesirable because a stable economy will correct itself]. Monetarists stick with this view in the face of countless experiences that reject its validity.