Tuesday, January 17, 2017

Ramanan — What Is “Crowding Out”?

J.W. Mason has a nice article What Does Crowding Out Even Mean? on his site The Slackwire. I agree with some aspects of it not all.
Let me offer a slightly different (but similar) perspective. First the definition. When an economist—typically a new consensus economist—uses the phrase “crowding out”, he/she means that if government expenditure rises, private expenditure falls without output rising.
That’s it: rising government expenditure will lead to a fall in private expenditure with no positive effect on output according to this. And since new consensus economists also talk of government expenditures as less efficient, it also means that they are saying that real output will fall – a proposition that follows.
But this is a highly unlikely scenario.…
The Case for Concerted Action
What Is “Crowding Out”?
V. Ramanan


Penguin pop said...

I can't believe there are so many mainstream economists who don't understand that the Fed sets interest rates. I've always wondered why.

Tom Hickey said...

The know that the Fed sets rates but they see it as a "reaction function." The Fed doesn't just pick rates out of the air but attempts to set the "natural rate" that would be set by a completely free market to optimize employment and price stability. There is no free market in this respect owing to government fiscal policy. So the cb "reacts" to shifts in fiscal policy and perceived effects with changes in monetary policy. Some advise doing this iaw a "rule," like a Taylor rule. In this sense, the cb is not "free" to set rates but is market-led and is just adding a correction.

mmcosker said...

Good lord, crowding out only happens if the government buys so much stuff that the public sector cannot acquire any real resources at a"feasible" price. Probably not an easy thing for the government to do, especially considering you can import what is not produced domestically. It is not a scenario that we are even on the verge of experiencing.

Postkey said...

Here is someone who 'believes' in 'crowding out'.

"Notice that this conclusion is not dependent on the classical assumption of full employment. Instead of the employment constraint that was deployed by classical or monetarist economists, we observe that the economy can be held back by a lack of credit creation (see above). Fiscal policy can crowd out private demand even when there is less than full employment. Furthermore, our finding is in line with Fisher’s
and Friedman’s argument that such crowding out does not occur via higher interest rates (which do not appear in our model). It is quantity crowding out due to a lack of money used for transactions (credit creation). Thus record fiscal stimulation in the Japan of the 1990s failed to trigger a significant or lasting recovery, while interest rates continued to decline. "


Tom Hickey said...

"Crowding out" implies that one factor is denying use of resources to another factor owing to some transmission mechanism involving rivalry or excludability.

If the phrase is not used that way, then it is being used as an analogy, which may or may not be apt. This can occur in the case that correlation is conflated with causation.

JW Mason said...

Thanks for pointing that out, Postkey. Werner's piece is aversion of my case 2 - public and spending and private investment compete for a scarce pool of money or liquidity. Personally I don't see how this works in a modern rich country, but Werner is a smart guy -- will be interesting to see why he disagrees.

Calgacus said...

Following Alain Parguez and Lauchlin Currie, something like what Werner suggests for Japan may have happened during the Great Depression. Though both are perhaps better described as more like "pump-priming" failing than "crowding out." The WWI Bonus passed over FDR's veto seems to have had a crappy multiplier effect, unlike the very robust ones of the job programs, and it even caused some local "crowding-out" inflation. And then its end helped spark the 37-38 recession. Parguez's comparison to France at the same time is also enlightening. France had even bigger deficits than the USA or Germany, but they were "bad deficits". So the bang for the franc was rather less than the bang for the mark and much less than the bang for the buck.