Fiscal Crowding Out:

Fiscal crowding out occurs when a rise in government expenditure from a budget deficit raises aggregate demand. Given a  constant money supply, the interest rates rise. The simulative effect of government deficit (or expenditure) will crowd out in greater or lesser degree a certain amount of private investment. The fiscal crowding out is usually explained in terms of the  Keynesian analysis. The mechanism is that the rise in government expenditure raises the aggregate demand. This sets in motion the multiplier process, which raises nominal income. The rise in nominal income requires more money for transactions purposes. Further as investment increases, the demand for labour also rises which increases wages and prices. The degree to which prices rise depends on the extent of unemployment prevailing in the economy.

The nearer is the economy to the level of full employment level, the higher will be the price level. When the economy is in full employment, the price level rises in proportion to the increase in government expenditure. The rise in price level leads to the rise in nominal income which in turn, diverts money balances for transactions purposes and decreases the quantity of money available for speculative purposes. As the money supply is fixed, the residual money supply contracts and interest rates rise. The rise in  interest  rates causes a fiscal crowding out of private investment with the increase in government expenditure. In a full employment situation, the fiscal crowding out is complete because government expenditure equals private expenditure which it displaces. If there is  liquidity trap, there is no crowding out.