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I'll bud in here, although the content might be better suited on another thread.

Economics is about expectations - a transactional, interrelated momentum consisting of earning, spending and saving. The car culture is not doing as badly overseas as in N.A. (Ford's having a good year in France!). Being the worst energy gluttons here in N.A., a diversification of energy supply would have been most useful here, as well. The business model known as "consumer driven domestic economy" is mortally damaged here, but not nec'y elsewhere.

Gov't spending will not provide long term growth - merely a slight increase in demand for goods and services. There is no doubt we are facing a huge, systemic challenge. Better use of existing resources, enhanced infrastructure (less waste of most everything), microcredit, facing up to externalized costs, buildings that produce the energy they need to function - we have to start somewhere.

James Galbraith recently nailed this one, putting it this way:

"Will the projected future deficit “crowd out” future private investment as so many claim? This is absolutely improbable. To the contrary, a successful program of public expenditure will create profit opportunities that will encourage private businesses, many of which will otherwise close, to stay open and eventually to expand. A general improvement of economic conditions can only lower, not raise, the presently prohibitive risk premiums on interest rates being charged private borrowers! There is no way that present or future public spending, even in very large volumes, would under these conditions raise long term interest rates generally by enough to offset the positive effects of an increase in activity and a reduction of risk. Quite the contrary! Public spending will crowd in, not crowd out, private investment.

"Whether they know it or not, those who argue a “crowding out” model are working from a mental construct under which the economy is always operating at or near full employment, and under which there is a fixed supply of credit resources, a pool which government and the private sector must share. This is not the case! We are far below full use of available
resources now and will certainly fall very much farther in the months ahead, whatever the new administration does. And there is no fixed pool of credit! The entire purpose of the capitalist banking system under the Federal Reserve Act, ever since 1913, has been to create an “elastic currency” not subject to fixed limits to the supply of finance. With due respect to those who continue to have reservations about “crowding out”, please stop. This is a moment when an unfamiliarity with the most basic economic and financial facts can be very dangerous to national well-being."

Marc: the first paragraph from James Galbraith is correct (it's the accelerator effect). But his second paragraph is not (generally) correct. In "normal" times, for example, with an inflation targeting central bank, the LM curve is vertical, and it's vertical because the central bank makes it so. An inflation targeting central bank (like the Bank of Canada) only allows an "elastic currency" for the very short run (6 weeks to be precise -- the time between Fixed Announcement Dates). In the medium term it adjusts money (or interest rates) to keep AD growing at the rate it believes compatible with the inflation target. Only in "abnormal" (ZIRP) times, does the nominal interest rate stay fixed, so the LM is horizontal. But it's the real, not the nominal rate of interest, which affects investment, and he missed the effect I'm talking about.

But I think Galbraith is basically correct even with that constraint. The supply of money expands to meet the demand for credit subject to usual lending conditions at the micro level and Bank oversight wrt inflation at the macro level. So it is exception not the norm that a public sector deficit could crowd out private investment. And even moreso given that something like 90% of capital investment is financed internally.

So it strikes me that the crowding out debate is not a particularly useful one to be having right now.

But given Bank oversight wrt inflation (keeping inflation on target), in normal times that constraint is very very binding. In other words, if the government runs a deficit, then the Bank of Canada WILL make sure it crowds out investment (plus consumption, plus net exports if applicable) by 100%.

But OK, in the US (but not quite yet in Canada) these are not normal times.

And maybe I am just putting an additional bullet in a dead horse (but I think my bullet is bigger and better than the bullets the other guys have fired!)

Sorry, chaps, it's not quite like that. And, speaking of bullets, you'll find some in this article - fifth paragraph down:

Environmental Banking
December 6th, 2008

Yeah, but I think the other arguments are stronger. Short term rates are at about 0, but medium and long term rates are still far from zero.

The strongest arguments are that due to the severe recession, the deficit spending will employ labor and capital that would just sit idle otherwise, increasing future real wealth, some of which will be invested, thus increasing the supply of real investment funds in the future. Moreover, if the government spending is on very high return projects of the kind the free market will grossly underprovide due to market problems like externalities, especially the pink elephant of economics positional/context/prestige externalities, then real wealth and the real supply of investment funds will increase tremendously in the future. And, the Fed can buy down real interest rates to counteract any deficit spending effects anyway, without worry about inflation, because of the recession.

Plus, after the recession is over, taxes can be raised, hopefully just on the wealthy, to turn the deficits into surpluses. Certainly it would be far better for growth to raise taxes on the wealthy than to stop high return government investments. We're clearly a lot better off with more basic scientific and medical research, infrastructure, alternative energy, etc., than more yachts, mansions, $5,000 suits, etc.

Richard, argument is good but could be qualified. America's income was once taxed at an 80+% rate at the high end: too high. In America people have gotten poorer since Reagan (I doubt this was true in Stalin's USSR) and Canada is on same path. Clearly Harper's Cgy economics school is part of the economic hijacking devoted to making rich people richer instead of maxing health/happiness. But rich people buy computers and electronics that fund R+D leading to medical equipment electronics and 3rd world cell phones. The rich at current levels keep the poor down (rich Canadian media excepting Torstar undoes public school education), but most service economy employment is far from worthless; kind of acts as a GAI precursor for those waiters and sales clerks who otherwise wouldn't use time to learn or teach something. Infrastructure is a nebulous term. Port, bicycle, rail and transit investments act to shrink road use, I think. Only one of oil sands and wind turbine power line infrastructure, acts to destroy Earth.

Banks can afford not to lend during liquidity trap. Not earning interest sucks but breaking even is not a bad consolation prize. Frankly they represent wealthy interests and can afford the attrition. Middle and poor workers can't afford the "attrition" of being homeless or their wives fucking bankers. If banks can't earn interest, giving money to unemployed to work, works.
Let's tell it like it is: rich people (bankers) thumb noses at inferior returns, but unemployed lower classes will take the scraps and can't afford to hoard.

Wow! This debate is taking off! But back up guys, back up a minute.

Start with the textbook ISLM, closed economy, fixed price level, unemployed resources, central bank holds M fixed, so there's an upward-sloping LM curve, investment depends (negatively) on the interest rate only.

In that model you DO get partial crowding OUT of investment, even though there's unemployed resources.

Now make the LM horizontal (ZIRP for instance, central bank holds i at 0). Now you get zero crowding out.

Now add in an effect of Y on investment (positive). Now you get crowding in.

Now add in a Phillips curve, and some sort of adaptive expectations on inflation/deflation, recognise that Investment depends on real not nominal interest rates, hold nominal rates at 0%, and you get more crowding in (which was my point).

Richard: You say "....the deficit spending will employ labor and capital that would just sit idle otherwise, increasing future real wealth, some of which will be invested, thus increasing the supply of real investment funds in the future." I'm with you up to your first comma, but then disagree. First, it does not increase future real wealth, unless capital is crowded in (not out), because future real wealth IS the future stock of capital. Second, because capital is NOT what is invested (the first is a stock of machines, the second is a flow of production of new machines). What gets invested is part of the flow of current income/output. Plus, if we are in a world of unemployed resources, where output is demand-constrained, not supply-constrained, an increase in the capital stock (more machines) does not increase output/income (though it will do when the recession is over and we get back to the natural rate, where output is supply constrained).

Go easy on the bankers Phillip. Bankers are people too ;)

sustain ability: I skimmed that article you linked to. I could make almost no sense of it, other than it's environmentalists wanting to abolish the Fed. If environmentalists want to destroy the monetary and financial system, so we all go back to living in caves and mud huts, I think they should come out and say so clearly. (Or maybe they think that the people running the financial system are already doing a good job of destroying it, and if so they should just leave well alone ;).

20 years ago, in another lifetime, I did a BA in economics. After spouting standard theory to real business people and having them laugh in my face a few times, I've learned to be deeply skeptical of what I learned in school.

Personnally, I think the level of interest rates is irrelevant to investment, unless you have usurous rates over 20%. When times are good, businesses are agressive competitors and will make whatever investment is required to compete, innovate, develop new products and increase their market share and profits. When times are bad, they are more interested in survival and avoiding bankruptcy, so they slash investment.

In my experience (and I've worked on a few feasibility studies for major investment projects), businesses won't invest in a new project unless their estimated returns are in the 10% to 20% range, after financing costs. The availability of financing is far more important than whether interest rates are a few points higher or lower.

Some projects are even done for reasons of prestige or status, not for profits. For example a chain of stores or restaurants may want an outlet at a prestigious location, even if it looses money.


Alex Plante


Please take a look at this post from Nobel Prize winning economist Paul Krugman. GDP per capita is higher since Reagan. Moreover Reagan's growth rate was not very good, even though it was massively debt fueled and investment poor, really hurting growth longer-term, after Reagan's presidency. And even though it was coming off of the worst recession since the great depression, and the large monetary expansion that followed. Growth before Reagan was much better (and far more evenly distributed) in the much higher-tax period post-war up until 1981, and growth after Reagan was better in the higher-tax period of Bush I and Clinton.

Taxes on the rich are nowhere near high enough that they hurt growth. The key reasons are the income and substitution effects and backward bending labor supply curves, and the inefficiency of spending by the rich due to free market problems like externalities, especially the pink elephant of economics, positional/context/prestige externalities, as opposed to taxing the rich higher than currently and using the money for high return investments of the kind the free market will grossly underprovide due to market problems like externalities, asymmetric information, giant economies of scale, monopoly problems, inability to price discriminate well, and many more.


You do say, "In that model you DO get partial crowding OUT of investment, even though there's unemployed resources." You use the word partial, not complete, so there is an increase in investment, especially if you use the workers and capital that would just be idle anyway to produce highly productive investment goods (or capital, including intellectual capital, like education and scientific, technical, and medical advancement), especially really high return investment goods like in alternative energy.

But in addition, if the deficit spending increases real interest rates, that can be counteracted by the Fed pushing them back down again by cuts in the discount rate (basically exhausted now), or printing up money and buying up longer term securities until their real rates come back down. With the severe recession the fed doesn't have to worry about this causing inflation.

Richard: by "partial crowding out" I mean (and this is standard usage in Macro), that if the government deficit goes up by $100, then private investment goes down, but by less than $100. "Full" or "100% crowding out means private investment goes down by $100. "Crowding in" means private investment goes up.

Ok, but I was speaking about total investment (and really total NPV), which includes government and private.

So anything that drives the rate of inflation or deflation toward 0 crowds in investment?

Richard: OK, I'm with you now. If the deficit finances government investment expenditure (rather than government consumption expenditure, tax cuts, or transfer increases), then yes, partial crowding out of private investment means total investment increases (but by less than $100.

artan: No. for a fixed nominal interest rate (and this assumption really only makes sense when it is at zero, and the Bank of Canada wants to lower it, but obviously can't), then there is a positive relationship between expected inflation and investment demand. So starting at zero expected inflation, lowering it (into deflation) will reduce investment, and raising it (into inflation) will increase investment.

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