Question

how might federal deficits crowd out private domestic investment? How could this crowding out affect future living standards?

Answer 1

A situation when increased interest rates lead to a reduction in private investment spending  is called crowding out.

There are three different ways in which a national government can fund its spending: 1) taxes 2) printing money 3) borrowing.
When the government has an expansionary fiscal policy, runs a deficit and finances this deficit through borrowing, crowding out takes place.

It is so because when these things take place, the demand for loanable fund rises that causes the interest rate to rise.

The interest rate is the price of money because investors borrow money to invest and then they make monthly loan payments. These ongoing loan payments are an ongoing cost to them that directly affects their profit margins. For example, when interest rates are low, their loan payments are low and their profits are higher.

However, if interest rates are high, their loan payments are also high, and that means their profits are much lower. When interest rates get high enough, investors will stop investing because rates are so high and profit is so low that there's no incentive to invest anymore. It means when the government runs a deficit and finances this deficit through borrowing,interest rate rises and as interest rate rises,the private investment falls means crowing out.

So reducing private investment reduces the profit or income earned by private people and thus this crowding out adversely affect the future living standards.