Monday, January 16, 2017

J. W. Mason — What Does Crowding Out Even Mean?

In terms of a model, "crowding out" means that increasing the value of one variable diminishes the value of another or other variables.

This occurs in a model of an idealized or stylized world. If the claim is the the ideal or stylized world corresponds to the real world with respect to the factors involved, then it becomes an empirical question that requires examination of data and measurement.

So the first questions are about the model. What assumptions does it depend on?

The next question is whether the assumptions apply to the real world that the model putatively represents. Do the functions adequately represent actual transmission mechanisms?

The question after than is whether is too simplistic to be useful in assessing the real world situation(s) involved in the debate that are in question, e.g., relating to policy formulation or decision making.

This involves distinguishing between general case and specific cases. A general case model may not hold locally owing to institutional arrangements, for example, voluntary political imposition of a debt ceiling limits the general case based on operational analysis of a general system by limiting fiscal space arbitrarily.
Below, I run through six possible meanings of crowding out, and then ask if any of them gives us a reason, even in principle, to worry about over-expansionary policy today. (Another possibility, suggested by Jared Bernstein, is that while we don’t need to worry about supply constraints for the economy as a whole, tax cuts could crowd out useful spending due to some unspecified financial constraint on the federal government. I don’t address that here.) Needless to say, doubts about the economic case for crowding-out are in no way an argument for the specific deficit-boosting policies favored by the new administration.
This is definitely a should-read for people interested in MMT and policy.

I don't want to provide a spoiler — the points are summarized after the explanation — but it may be easier to grasp the points by knowing them beforehand.
So now we have six forms of crowding out:
1. Government competes with business for fixed saving.
2. Government competes with business for scarce liquidity.
3. Increased spending would lead to higher inflation.
4. Increased spending would cause the central bank to raise interest rates.
5. Overfull employment would lead to overfast wage increases.
6. Increased spending would lead to a higher trade deficit.
The next question is: Is there any reason, even in principle, to worry about any of these outcomes in the US today? We can decisively set aside the first, which is logically incoherent, and confidently set aside the second, which doesn’t fit a credit-money economy in which government liabilities are the most liquid asset. But the other four certainly could, in principle, reflect real limits on expansionary policy. The question is: In the US in 2017, are higher inflation, higher interest rates, higher wages or a weaker balance of payments position problems we need to worry about? Are they even problems at all?
J. W. Mason's Blog
What Does Crowding Out Even Mean?
JW Mason | Assistant Professor of Economics, John Jay College, City University of New York

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