Crowding Out: A New Subject
By Arnold Kling
It appears to me that real interest rates were undeniably higher during the Reagan administration than during, say, the past four quarters of the Obama administration
I see that we have managed to change the topic from “liquidity trap” to “crowding out.”
I don’t recall where I raised the topic of crowding out. Crowding out, for those of you who are new to this stuff, is when government deficit spending raises interest rates and thereby reduces private investment.
There are at least three Keynesian arguments against the existence of crowding out.
1. Excess capacity in the economy. A flat aggregate supply curve, in textbook-speak. With excess capacity, the economy can produce output for government stimulus and still have plenty to spare to produce capital goods for business investment.
2. Inelasticity of spending with respect to interest rates. A vertical IS curve, in textbook-speak. That is, consumers and businesses do not care much about interest rates when they make decisions about buying houses, cars, or capital equipment. Instead, they care mostly about their income, wealth, and profits.
3. Nominal interest rates are stuck. A flat LM curve, in textbook-speak. The infamous liquidity trap, in which no matter how much borrowing comes from the private sector and government, the interest rate stays the same.
I don’t buy (3) at all. I tend to doubt (2), but I could be persuaded. I think that (1) is likely to be true. I am not a believer in crowding out in a deep recession.
My problem with fiscal stimulus is that I believe we need permanent adjustment to new sustainable patterns of trade, not temporary moves. I think that if you want to eliminate unemployment in a meaningful way, you have to know something about where people ought to be employed, and Washington does not have that information. It is not that I expect deficits to crowd out other economic activity. I don’t think they will create any real economic activity to begin with. But those are my own crackpot views, and if you dispute them you’re probably right.