crowding in and out Flashcards
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
What fundamental financial fact drives crowding out
that financial and real resources are ultimately scarce, and if one sector of the economy increases its use of these resources, fewer are available for use in other sectors.
What is the Ricardian Equivalence
This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.
The theory argues that people will save based on their expectation of
increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.
What did Barro say to support the Ricardian Equivalence
an increase in government spending will lead individuals and organisations to expect interest rates to rise in the future, they will save more in order to pay higher interest rates.
What is the evaluation of crowding out
it may be a weak effect, this depends on the various elasticities that exist in the relevant markets.
if the supply of loanable funds is elastic and the demand for capital is inelastic, the impact of higher interest will be relatively small.
What evidence did Enrice Moretti from MIT find about federal spending to oppose the ‘crowding out’ theory
Government spending leads to an increase in private spending; a ‘crowding in’ effect
What are 3 reasons for the crowding in effect
- Frontier technology projects have extremely high fixed costs so by letting the public
sector fund the research, it allows the private sector to realise higher
profits. -
“Spillover effects”, where new technologies find different applications
in the private sector. GPS, for instance, was first developed to help
missiles find their targets -
Credit constraints on the private sector, where a project is difficult to
fund without government support due to, say, an economic downturn.
Why does frontier/speculative funding have a crowding in effect
the potential outcomes from speculative research and development are inherently unknowable, which makes a new project impossible to justify commercially.
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
