So there's a comment above like

// Instead of watching root, watch directory in root to avoid watching excluded directories not needed for module resolution

How does that interact with stuff like node_modules which is typically ignored, but which typically is included into the program anyway?

https://github.com/microsoft/TypeScript/pull/53675/files#diff-cb9561c40fa7f1bbefdfa8fa029b8e3d8e07908806ddcb1518f2b69be43e45ceL884 is shows how we pass true but set false and expect it to be false

So there's a comment above like

// Instead of watching root, watch directory in root to avoid watching excluded directories not needed for module resolution

How does that interact with stuff like node_modules which is typically ignored, but which typically is included into the program anyway?

say a.ts has import to bar. The failed lookup location will be root/node_modules/bar/bar.d.ts
At this point we want to watch root/node_modules instead of watching root. This helps with scenarios where there are unrelated folders in root. Eg say you have root/scripts. If you were watching root, you would need to go through all the the the resolutions and their failed lookups only to find that it doesnt matter. So lot of unnecessary work.