12) CROWDING OUT (AND IN) - MMT Flashcards
The UK, like most countries, regularly runs a budget…
Deficit, this means that Government Expenditure is greater than Taxation revenue (G>T)
What is the government’s borrowing requirement for the year known as?
Public Sector Net Borrowing Requirement (officially known as the PSNBR)
What are the different approaches to borrowing?
The most common is the sales of UK government bonds, otherwise known as Gilts
How are Gilts sold?
These are sold in the bond market and heavily traded by investors
What are the characteristics of a bond?
A bond is like a loan - the business or government selling the bond is becoming the debtor of the buyer, who now owes an IOU that the seller will need to honour at a future date
Who is the bond market for?
The bond market is not just for the sale of government bonds, almost all big private sector businesses also sell bonds.
Why do big private sector businesses sell bonds?
In order to raise the funds that they need to expand or diversify
What choice of bonds do investors have?
They have a choice of whether to invest in government bonds, corporate bonds or a mixture of the two
Why might it be more difficult for private sector businesses to raise the funds they need to invest?
Investors do but have unlimited funds to invest. If they invest more of their funds in government bonds it means that there are less funds remaining for them to invest in corporate bonds. This may then make it more difficult for private sector businesses to raise the funds they need to invest. One reason this may happen is that government bonds, especially in a powerful developed economy like the UK, carry less risk than corporate bonds
Why do government bonds carry less risks than corporate bonds?
The UK government is not going to go bankrupt whereas private sector organisations, even major financial ones like Credit Suisse, constantly run this risk. Therefore, investors may be more attracted to the safety of government bonds
What is the crowding out effect?
The reduction in private sector investments induced by increased public sector spending
What is the point of increased government borrowing?
Is to increase economic growth, increasing AD by increasing G
What do people argue about ‘crowding out’
That increased G, funded by borrowing means less funds available to businesses to expand, (I) meaning businesses may be able to export less and also may not create as much new employment, meaning I, C and X may all decrease. Therefore, the increase in G is outweighed by a decrease in C, I and X, meaning that the expansionary fiscal policy has failed to achieve economic growth
Why do most observers agree that private sector investment (I) is more efficient that government investment (G)?
This is due to government failure, a tendency of public sector organisations to waste money. The profit maximisation motive of big businesses makes waste less of an issue in the private sector
What is a weakness of the crowding out argument? (Talk about a weak economy)
If the economy is weak and business confidence is low, then private sector businesses may not be looking to expand. In that situation the investors are buying government bonds as there may not be much alternative - (there is nothing to crowd out)
