Saturday, 17 July 2010

Crowding out nonsense.

More nonsense is written about crowding out than almost any other subject in economics. Crowding out is allegedly a problem. The reality is that it is not, and for the following reasons.

Governments (in the sense of “government and central bank combined”) borrow and spend for two reasons. The first is with a view to stimulus. Obviously such stimulus would be thwarted if the result of the borrowing is increased interest rates. Where stimulus is the objective, a government is hardly going to let interest rates rise as a result of the borrowing is it? And this is exactly what has happened in the last two years or so: more borrowing plus interest rate cuts.

As to the idea that public spending crowds out private spending because the former makes it difficult for the latter to obtain resources to meet demand, this idea is nonsense. Of course the latter scenario is a possibility, but where this possibility becomes a reality, the relevant economy is very near capacity, and that is not the scenario we are dealing with. We are dealing with the scenario where stimulus is required, that is where the economy is a long way from capacity.

A second reason for borrowing is so as to fund spending (with stimulus not entering into the picture). Funding say additional roads and schools where an economy is already at full employment, is an example.

In this case, crowding out is exactly what is wanted. That is, half the purpose of borrowing is to suppress or “crowd out” private sector spending so as to make room for more public sector spending. (Advocates of Functional Finance would, quite rightly, replace the word “half” in the latter sentence with the phrase “the whole”, but that is incidental.)

Conclusion: there shouldn’t be any crowding in a falling interest rate scenario. As to the second above mentioned scenario, that is where crowding out is positively desirable, the only problem is not knowing the exact extent of and effect of crowding out.

In other words the folk who have been worrying about crowding out over the last two years or so (a falling interest rate scenario) are worrying about nothing.

No comments:

Post a Comment

Post a comment.