When government expenditure exceeds tax revenue and money is borrowed to cover any shortfall to avoid reducing expenditure or increasing taxes.
In order for the government to finance the budget deficit they must borrow from the private sector - pushing up the demand for loanable funds and interest rates. Despite allowing the government to spend more, this can lead to offsetting crowding-out effects. The diagram below shows the effect of running a higher government budget deficit in the loanable funds market.
