As Congress mulls over an economic stimulus package, its members have to decide whether they believe government spending always reduces private-sector spending or if there are times when the government can actually boost private spending.
Many conservative politicians and economists think government spending inherently “crowds out” household consumption or business investment. But many others believe that whether such crowding out occurs depends on circumstances.
It is like Robert Frost’s poem, “Mending Wall.” Frost’s neighbor thinks building walls along property lines always is prudent: “Good fences make good neighbors.” Frost, however, wants to know the purpose — “what I was walling in or walling out” — before deciding if a fence is good or bad.
Economists face similar disagreements about government spending. For some, government outlays are, at best, a necessary evil and should be held to a minimum at all times. They note that any government spending ultimately has to come from taxation. Taxing private households and businesses reduces the money these entities can spend. Government spending thus inherently “crowds out” private spending.
Given the usual economists’ qualification of “all other things being equal,” most economists agree that fears of “crowding out” often are valid. But some argue there are circumstances when such spending has a very different effect, that of “crowding in.”
These economists follow the ideas of John Maynard Keynes, who argued government could ameliorate the bad effects of the business cycle — booms and busts — with off-setting monetary and fiscal policies.
Keynes said that when a recession threatened, a nation’s central bank should increase the money supply to lower interest rates and in a boom, do the opposite.
On the fiscal side, a government should cut taxes and increase spending when recession looms. Yes, this could cause a budget deficit. But because such government stimulus would keep the output of goods and services higher than it would be otherwise, the additional spending would not crowd out any private-sector spending, either on investment or consumption.
Instead, by keeping an economy from sliding into a recession in which labor, factories and other productive resources would sit idle, deficit spending could actually increase private-sector business investment and household consumption. This, ardent Keynesians argue, could be termed “crowding in.”
That is the theory behind the calls by both the outgoing Bush administration and the incoming Obama one for stimulus packages. What would be a bad idea in a normal economy — running a larger budget deficit — is a good one when facing an economic storm.
Not all economists agree. Milton Friedman and other monetarists opposed such attempts to micromanage the economy. Rational Expectationists like 1995 Nobel Laureate Robert Lucas argue such countercyclical policies are counterproductive.
But right now, Keynesians seem to have a large majority. Congress is split, with Democrats wanting a larger package. Many Republicans are skeptical, but may be won over if much of the package involves tax cuts.
Many Keynesians would argue that direct government spending is more effective in a situation like this than reduced taxes. When households and businesses are fearful, lower taxes get socked into savings rather than additional consumption or investment. That apparently happened with much of the first $600-per-person stimulus package parceled out in 2008.
2009 Edward Lotterman
Chanarambie Consulting, Inc.