Crowding Out and Its Critics(December 1975, FEDERAL RESERVE BANK OF ST. LOUIS)

December 1975, FEDERAL RESERVE BANK OF ST. LOUIS
By KEITH NJ. CARLSON and ROGER W. SPENCER

Introduction:

DOES Government spending displace a near equal amount of private spending? This notion, popularly known as the “crowding- out” effect of Government expenditures, has recently gained wide-spread attention at two levels.

• First, at the policy level, public officials have expressed concern, that massive current and projected Federal deficits will have a deleterious effect on private capital expenditures for some time to come.
• Second, at the academic level, “crowding out” is at least one of the issues which helps to distinguish between followers of the two major macroeconomicschools of thought Keynesians andmonetarists.

This article focuses on “crowding out” from more of an academic than a practical policy point of view.Policy implications can he drawn from this discussion, but, for the most part, the abstract economic models used in academic circles are not easily adaptable to observable phenomena...

... The IS-LM apparatus has distinct limitations, but because of its widespread use as a pedagogical device, it serves a useful function in highlighting the issues in the crowding-out controversy. The subject of crowding out is approached {here} by first investigating a number of separate “cases” which provide various explanations of how crowding out might occur. Next, the role of stability considerations in the controversy is assessed. Finally, several econometric models are examined to determine what empirical implications they have for the crowding-out issue. ...

(Continued on: Crowding Out and Its Critics)

※ 메모:

• Robert Rasche constructed a sophisticated version of the IS-LM apparatus which was based primarily on the textbook presentation of Robert Grouch.
  
  The model included wealth in the consumption and money demand functions, a Government budget constraint, and a labor sector, as well as an endogenous price level. According to Rasche’s analysis, an increase in real Government purchases, financed either by taxes or debt issuance, increases aggregate demand, and, consequently, the commodity price level. Although there may also be a rise in consumption owing to a presumed positive effect of debt issuance on wealth, there is an offsetting increase in the demand for money associated with such wealth gains(see Figure 5). The rise in the price level reduces private consumption as well as the real supply of money. Together with a decline in the amount of private investment owing to an increase in interest rates, these factors tend to crowd out an amount of real private expenditures equivalent to the increase in Government purchases. Crowding out occurs in this model in real terms, but with a higher price level, crowding out is not likely to occur in nominal terms.
• These results lead Rasehe to conclude that nominal crowding out requires “extreme” assumptions about the interest elasticity and the wealth elasticity of the demand for real cash balances. It should be pointed out, however, that Rasche, in his manipulation of the model, did not ailow for a Keynes expectation effect, an ultrarational direct substitution effect, or a Knight effect, all of which may leave the aggregate demand curve unmoved in response to an initial increase in Government spending.

• To illustrate the Friedman case, consider Figure 6. The IS curve is drawn quite flat, reflecting Friedman’s statement that “‘saving’ and ‘investment’ have to be interpreted much more broadly than neo-Keynesians tend to interpret it,...” Though Friedman does not emphasize it, this interpretation puts him close to the Knight case, because the implication of more inclusive investment tends to flatten the IS curve and dampen the power of fiscal actions. In addition, Friedman indicates that the wealth effects of increased bond holdings on spending will be minimal, because increases in debt would tend to be offset by an increase in expected tax liabilities.
• Perhaps an even more important reason to doubt the long-run expansive capacity of increased Government spending is its effect on the future production of goods and services. Friedman notes that debt supported Government spending leads to a “reduction in the physical volume of assets created because of lowered private productive investment.” In other words, potential output in the future will be lowered relative to what it would otherwise be with the transfer of resources from private investment (which generates the future capital stock) to Government spending (which absorbs the capital stock).