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Do Government Deficits Crowd Out Consumer And Investment Spending?

John Heim ()

Rensselaer Working Papers in Economics from Rensselaer Polytechnic Institute, Department of Economics

Abstract: This paper econometrically tests whether deficits financed by government borrowing “crowd out” business and consumer spending reductions by reducing credit availability. To test the hypothesis, the government deficit variables are added to consumption and investment models to see if they increase explained variance, negatively impact consumption and investment spending, and are statistically significant. U.S. data for 1960 - 2000 is tested. A demand-driven econometric model, patterned after the work of Klein and Fair and containing eight behavioral equations is used to estimate crowd out effects. Demand models seemed appropriate because they, “provide the foundation of much of our current understanding of economic fluctuations “(Mankiw (2007), because demand fluctuations appear to have caused the recent economic crisis (Romer 2010), and because the fiscal policy prescriptions of demand models clearly lose some or all of their effectiveness if crowd out simultaneously reduces consumption and investment spending by reducing private credit. The findings indicate government deficits financed by borrowing systematically crowd out private consumption and investment spending. The findings also indicate that increases the savings components of M2 can offset part of this crowd out effect. Finally, consumption and investment functions with crowd out explanatory variables predict generally Keynesian “IS” curve coefficients model more accurately than models without them. The sign of the tax variable in actual econometric tests of IS curve was positive, contrary to predictions from no-crowd out Keynesian models The sign of the tax variable in the IS curve could only be accurately predicted from econometric estimates of consumption and investment equations containing crowd out. Findings for the government spending variable also showed crowd out markedly reduced its stimulus effect, in some model completely offsetting it.

JEL-codes: C50 C51 E12 E21 E22 (search for similar items in EconPapers)
Date: 2010-10
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