Arnold Kling  

Crowding Out or Crowding In?

State GovernmentPensions... The Immigrant in My Basement...

Greg Mankiw writes,

I am not sure how convinced I am by these findings. And even if they are correct, I am not sure what model I should use to explain them and to what extent that model would apply to the extraordinary economic circumstances we now face. At the very least, these puzzles should give us reason to pause when using the Keynesian framework for policy analysis. There is still a lot about macroeconomics that remains deeply puzzling.

He is referring to recent empirical work suggesting the government spending crowds out investment, so that spending might be less effective as a stimulus than a tax cut.

Thirty years ago, the claim was made that fiscal stimulus crowded in investment. In those days, empirical work showed that investment responded strongly to changes in output (the "accelerator" model) and weakly to changes in the cost of capital. So, if government spending increased output, investment would go up.

I guess we're supposed to believe that newer research is more technically sound. But, honestly, I wonder whether the new research is even less reliable than the old research.

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CATEGORIES: Macroeconomics

COMMENTS (5 to date)
bgc writes:

From reading - in Sex, Science and Profits by Terence Kealey - about crowding-in and out in relation to science funding, I got the feeling that the direction of action varied according to circumstances.

The government building roads increases private spending on cars - crowding in. But government speding on science seems to reduce private R&D - crowding out.

If 'infrastructure' spending actually goes into jobs, rather than roads - ie into managers and administrators salaries rather than strips of tarmac - I could imagine this could crowd out private spending in various ways depinding on what the administrators are doing (as well as what they might be doing otherwise).

fundamentalist writes:

That's the problem with trying to distill theory from data alone. The theory seems to fit the data until the data change, or else everyone disagrees with your methods, or data source, or statistical technique or something else. Economics is not physics. The coefficients don't stand still. In economics, theory must precede data anlysis or people will torture the data until it confesses to whatever they think it should say.

Mick writes:

The earlier work may have yielded different results because government investments were heavily into war and monumental infrastructure (highways, dams ect...). Monumental infrastructure stimulates investment as long as it is marginally useful and of course government involvement in war stimulates a great deal of private activity on the looting side.

Technology and services are different beast however. When not waging a war or building a pyramid state investment tends to warp natural information flows and in the long run creates bubbles, and once those bubbles burst, we of course hear how we need more government investment to prevent bubbles...

Mr. Econotarian writes:

I would be unsurprised if spending on projects that are difficult to do in the private sector because of transaction costs (like buying out thousands of homes to build a road) might be positive for the economy, whereas spending that duplicates existing spending (education, health care, etc.) might be negative.

fundamentalist writes:

Austrians admit that Keynesian stimuli, whatever the variety, will boost the economy in the short run if idle resources exist. Austrians have pointed out many times that Keynes assumed a large supply of idle resources. The problem with such stimuli appears in the mid-term when we have used up the idle resources. If the stimuli continue, then they do nothing but re-ignite the business cycle. The same happens if the stimuli are injected too soon, before idle resources accumulate. So the timing has to be precise. Austrians are humble enough to realize that no man has the knowledge or wisdom to execute the stimuli at the perfect time. Even Friedman emphasized the incompleteness of data, the lack of understanding of how macro works, and the long lag time between policy implementation and its effects, which can be up to two years.

So Austrians say forget the artificial stimuli and remove the governmental obstacles that prevent the natural market process of recovery. In our case those would be the moral hazard of gov bail-outs. I think the credit markets would have fixed themselves very quickly had no bank expected a bail-out. The markets froze because banks knew they could get a better deal from the Feds than from the market if they held out long enough and screamed loud enough.

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