The great crowding out argument is a waste of time, ink and paper.

Hundreds of thousands of hours have been expended in academia over the last century over the argument as to whether government borrowing “crowds out” private sector employment. The alleged problem is that when government borrows, this raises interest rates, which in turn stifles private sector economic activity.

There is one awkward fact which is actually a big hint that the whole argument is a waste of time, namely that sometimes governments actually WANT crowding out to take place. This occurs where government borrows AS A SUBSTITUTE for tax.

Half the purpose of tax is to rein in private sector activity or private sector demand so as to make room to the relevant public sector activity (e.g. make labour available for such public sector activity).*

Now this makes a bit of a nonsense of the “crowding out doesn’t occur” argument, doesn’t it?

To put that in more general terms, where government WANTS crowding out to take place, it will LET interest rates rise, or deliberately raise them, or impose some other deflationary measure.

In contrast, where government borrows with a view to stimulus, it JUST WON’T LET interest rates rise in consequence. Indeed, the chances are that the relevant government will be LOWERING interest rates!

To that extent, the whole question as to whether government borrowing crowds out is a waste of time.

A possible answer to the above argument is that it would nevertheless be nice to know the EXACT EXTENT of crowding out. Well, sorry, but not even this excuse for the argument stands inspection, and for the following reasons.

Where government borrows with a view to stimulus, it won’t let interest rates rise, and indeed, will probably lower them. And this is done by creating money ex nihilo and buying government bonds. But wait a moment: when government borrows, it CREATES government bonds!

Now what is the point of this exercise? That is, what is the point of creating and distributing something, only to buy it back a few weeks later? There is no point!

Put that another way, where governments go through the motions of borrowing with a view to stimulus, they actually end up effecting the stimulus by plain old money printing. Thus we don’t even need to know the extent to which crowding out takes place!


Abba Lerner.

And wouldn’t you know it: Abba Lerner advocated effecting stimulus by plain old money printing rather than by having government borrow and spend.

Abba Lerner and Modern Monetary Theory win again.

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*To be more accurate, the CONVENTIONAL WISDOM is that the purpose of tax is obtain money for government spending. In contrast, as the advocates of Modern Monetary Theory correctly point out, collecting money cannot possibly be the purpose of taxation because governments can produce any amount of money any time from the printing press. Thus the REAL purpose of tax is to rein in private sector demand to a level at which the additional demand coming from the public sector won’t be inflationary.

Moreover, it is highly unlikely that the amount of money that needs to be collected in tax so as to rein in private sector demand by a given amount will exactly equal the amount of demand stemming from spending that amount of money on public sector projects. That is, the idea that one needs to collect exactly £X in tax to cover £X of government spending is actually nonsense: the final nail in the coffin of the above mentioned conventional wisdom.