Feb 14 2009

Will the stimulus package “crowd-out” private investment and reduce long-run growth potential in America?

CBO Director’s Blog » Macroeconomic Effects of the Senate Stimulus Legislation

The February 9th edition of the excellent NPR show, Planet Money reported on a letter sent from the director of the Congressional Budget Office to the Senate, forecasting the short-run and long-run macroeconomic effects of the House Stimulus Package.

It turns out the director of the CBO has his own blog on which he published his letter to the Senate. Here are some highlights:

CBO estimates that the Senate legislation would raise output by between 1.4 percent and 4.1 percent by the fourth quarter of 2009; by between 1.2 percent and 3.6 percent by the fourth quarter of 2010; and by between 0.4 percent and 1.2 percent by the fourth quarter of 2011. CBO estimates that the legislation would raise employment by 0.9 million to 2.5 million at the end of 2009; 1.3 million to 3.9 million at the end of 2010; and 0.6 million to 1.9 million at the end of 2011…

Most of the budgetary effects of the Senate legislation would occur over the next few years. Even if the fiscal stimulus persisted, however, the short-run effects on output that operate by increasing demand for goods and services would eventually fade away. In the long run, the economy produces close to its potential output on average, and that potential level is determined by the stock of productive capital, the supply of labor, and productivity. Short-run stimulative policies can affect long-run output by influencing those three factors, although such effects would generally be smaller than the short-run impact of those policies on demand.

In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt.  To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some provisions—such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislation’s budgetary cost. Including the effects of both crowding out of private investment (which would reduce output in the long run) and possibly productive government investment (which could increase output), CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net.

The fascinating thing about this letter from the Congressional Budget Office to the Senate is that it mentions so many of the Macroeconomic principles we teach in both AP and IB Economics.

  • The nation’s potential output (PPC) is “determined by the stock of productive capital, the supply of labor, and productivity”.
  • Fiscal stimulus’ effects, while possibly significant in the short-run, may result in less long-run growth due to “crowding-out” of private investment as the public puts its savings into government debt and takes it out of the market for loanable funds.
  • A stimulus package should be made up of “funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run.” The negative effects of crowding-out could be offset through responsible government spending.

I find this letter to be surprisingly positive. The short-run forecast seems optimistic: as much as 3.6% GDP growth and as many as 3.9 million new jobs by the end of 2010. The negative growth effects of the stimulus resulting from increased government debt and the subsequent “crowding-out” of private investment are not predicted to set in until 2019.

I always tell my students that humans are “short-run creatures living in a long-run world”. I have to admit, this short-run creature is inclined to think that a stimulus package that puts nearly 4 million people to work and turns the US Economy back onto a path towards growth within two years is probably worth the long-run risk of sluggish growth ten years down the road due to the decline in private investment resulting from the debt-financed spending today.

This letter from the CBO also seems to address a debate recently undertaken in the AP Economics teacher email list: whether deficit-financed government spending affects the supply of or the demand for loanable funds in the economy.

To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

This passage from the director’s letter indicates that it is the supply, not the demand for loanable funds that shifts, driving up real interest rates in the economy. Savers will take their money out of banks and other lending institutions and put it in government bonds, reducing the amount of capital available for private investment. This can be illustrated as a leftward shift of the supply of loanable funds.

Discussion questions:

  1. In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?
  2. Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
  3. Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

200 responses so far

200 Responses to “Will the stimulus package “crowd-out” private investment and reduce long-run growth potential in America?”

  1. Emily Kaminskion 10 Apr 2012 at 6:00 pm

    1. Crowding-out is significant in the short run for the fiscal stimulus, but in the long run it will result in less growth. This reduction in growth is due to the public putting savings into government debt and then uses it for loan-able funds. To reverse the negative long term effects from crowding-out the government would have to adapt responsible spending that can increase economic output. Crowding-out private investment would reduce stock of private capital and have potential output of the economy. It seems that crowding-out is positive for a recession in that if people hold their money in government bonds instead of a form used to finance private investment.

    2. The government borrows from its people by loanable funds in that savers will take their money out of banks and put them into government bonds. When there are higher interest rates in the bond market means that investors buy bonds instead.

  2. smarttikalevi2on 17 Apr 2012 at 11:21 pm

    You make your points clear, which is very important in these kinds of comments. And I have nothing bad to say about your answers. The point that I myself forgot to mention in my post was the distinction between short and long run effects on the first question, but you have done it very well here and I agree with you that in long run it will result in less growth.

  3. Emily Kaminskion 10 Apr 2012 at 6:11 pm

    3. As I partly said in question one, in the short run the growth will be increased but not in the long run. This is because in the long run the output would actually decrease unlike the short run when it increased. In the long term there will be an increase in government debt and this would happen people would rather hold their money from the government. The article also mentions positive outcomes for the long run in that it would increase the output. This would be negative for crowding-out. As a result there would be more productive government investment which would result in an increase in the output. In conclusion the article both explains the negative and positive parts of the stimulus.

  4. seun2on 10 Apr 2012 at 6:16 pm

    1.In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

    I think crowding out shouldn’t be a problem to consider during a recession at first, because it won’t have much effect in the short term anyways. The first thing the government should focus on is to get out of the recession and go back to growth in the business cycle. Like the fiscal policies planned now, the long term problems won’t take effect until 2019. Though crowding out of private invest caused by high interest rates will reduce expansion and economic growth later in the future, it is important to focus on the initial goal of recovering.

    2.Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
    There are ways governments can borrow money from American citizens. The government may increase tax rates, especially the indirect taxes as those are more controllable to adjust than to adjust direct tax as there are many problems in doing so. However, the most official way of “borrowing” money from the people is through bonds. There have been many bonds in the past when the government was short of money. For instance, the US government produced war bonds during WWII as they were short in budget in fighting the war.

    3.Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

    Fiscal stimulus in the short-run may provide an improved economy in the short run as employment increase and the income flow regenerates, but in the long run, as things such as crowding out occur, it will affect the spending in private investments because of the high interest rates that have accumulated.

  5. Ahamdockon 10 Apr 2012 at 6:54 pm

    1.In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

    Crowding out is a problem during recession because consumers and retailers experience an increase in both overall Aggregate Demand and Aggregate Supply, subsequently, the economy is not able to sustain this supply due to crowding out, while firms will suffer from debts. Moreover, people will choose to save rather than consuming their money. Since investment rate decreases, consumption will drop which will cause GDP rate to decrease.

    2.Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?

    Government will be able to borrow from private sectors through the process of purchasing bonds. The individual private sectors would purchase bonds, and the government will pay them back when they have enough revenue. Also, the government can enforce short term taxation on product goods.

    3. Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

    In the long run fiscal stimulus will be bad for the economy. Private sectors will have negative outcomes due to the government borrowing money. In short run, it is helpful since it will meet the demands and supplies.

  6. aaxler2on 10 Apr 2012 at 8:53 pm

    I'm not sure that during recession there is both an increase in AD and As. If this were so wouldn't there just be some inflation and perhaps even economic growth? However, I agree with you that the governments are able to borrow from their citizens through bonds.

  7. Samantha Kimon 24 Apr 2012 at 3:35 am

    I agree that the long run fiscal stimulus will be bad for the economy. However, I feel as though it is a necessary measure for even if the growth is sluggish in the long run there will still be growth. During a recession growth is falling and that is the most dire situation that should be addressed right away.

  8. aaxler2on 10 Apr 2012 at 8:44 pm

    •In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

  9. aaxler2on 10 Apr 2012 at 8:48 pm

    • In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?
    o Crowding out is not a problem in a recession, because expansionary fiscal policy is generally only used when the economic is contracting or in other words when there is a recession or depression. Recessions or depressions are often times caused by a lack of AD and expansionary fiscal policy a distinctly Keynesian idea aims to increase AD.
    • Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
    o The above statement is neither entirely true or entirely false. The US government borrows from the American people by issuing bonds or occasionally dipping into funds that are set aside for the American people like social security. However, the Government also just takes money in the form of taxes. Often times when there is a budget deficit taxes are raised to close the gap.
    • Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.
    o The answer really depends on whether one is a follower of the Keynesian versus the Neo-classical economic doctrines. A Keynesian economist was nearly definitely say no and that that fiscal stimulus will jump start growth that would continue in the long run. Will a Neo-classical economist would argue that fiscal stimulus simply is taking money from job creators and would hamper long term growth.

  10. rthornton2on 11 Apr 2012 at 1:56 am

    1.In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?
    Crowding-out is not a problem during a recession. Crowding out does not have many short-term effects, hence why it is established during a recession, rather it would have more long-term effects that would be seen a few years after the recession.
    2.Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
    The government “borrows” money from the American people through taxation and government bonds. A government bond is seen as a safe investment, as the government usually pays the citizens back, some time afterwards, with interest included.
    3.Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.
    A fiscal stimulus in the short-run would lead to a decreased growth in the long-run. The fiscal stimulus would cause crowding-out. With crowding-out, interest rates would increase, affecting the amount of investment into firms producing goods. With less investment, there would be less production, resulting in less jobs and economic activity, boosting unemployment, and causing a decreased growth in the long-run.

  11. nick mindorffon 16 Apr 2012 at 10:48 pm

    1. Crowding out in a recession is not necessarily a problem, as the effects of crowding out tend to be in the long term. As a recession is much shorter than a depression, this would not be an issue. However, should a depression be experienced, then crowding out would become a significant issue.

    2. The government borrows from the private sector, also known as the people, through a bond system. The private sector buys a bond, which is in essence a loan to the government. The money is later returned with interest.

    3. Short term economic growth is almost always a result of fiscal stimulus. Adding money into anything tends to cause growth. However, in the long run, there can be several problems with fiscal stimulus, as the crowding out effect becomes more prevalent.

  12. smarttikalevi2on 17 Apr 2012 at 11:15 pm

    1. I think crowding-out is a problem during a recession. This is because aggregate demand and aggregate supply would be low during a recession. The firms could overcome the recession, by using funds done by private investments, however if the government causes decrease in investment, the firms would have difficulties to recover.

    2. The US government sells bonds to the public, in order to gain money, which they then use to invest into economy. American citizens are able to buy these bonds, as the government takes money from banks. This enables the government to pay back to the banks and also to the citizens.

    3. Fiscal stimulus for an economy in the short-run will lead to an increase in economic growth. There is a problem though, with the long-run, as the effect of crowding-out can mess up the economic growth. This is because as the government spends on the economy, the interest rates will increase, which then will cause low investments by firms

  13. Konstantin Frankon 18 Apr 2012 at 10:31 am

    In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

    I think crowding – out might be a problem, as it will reduce the expansionary effect of increased government spending. However, to boost an economy it takes an increased aggregate demand. If firstly, the effect of the government spending will be smaller, thus people will spend less and secondly will already spend less because they "crowded out" their money to the government, the aggregate demand will only increase slightly, if at all. This is not beneficial for economic growth, which is needed during a recession.

    Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?

    A budget deficit occurs, when the government expects more tax revenue than it actually receives. Borrowing money from the private sector can be done by using two schemes. Firstly, by taxing. I adapt this idea from Jessica Kenny. She says that the government takes taxes from the people, however the debt is only created because it tries to improve the average standard of living. Therefore, people are borrowing money to the country, and receive therefore, hopefully, a country that has a fairer distribution of wealth and a higher standard of living.

    Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

    I think it really depends on the situation. It is hard to predict, whether a fiscal stimulus will have the expected effects, like for example the "trickle down" effect, or if people will put their money aside, even in the long run. However, it should often show increased growth, as for example many fiscal stimuli try to increase the aggregate demand, by smaller taxation. Many people react to these and therefore I would expect an increased growth. Nevertheless, it is questionable, whether the response to the stimuli will come at the right moment.

  14. Samantha Kimon 24 Apr 2012 at 3:32 am

    In response to your first question, I feel as though it refers more in the long-term. During a recession, however, when much of the thinking if short-term, I do not feel as though it will be a problem. After all, if you were a person with money and wanted to make more money, and in reality that's what all of us want to do, would you want to invest in a failing market. During a recession economic growth cannot happen without government investments especially since private investments are decreasing.

  15. Samantha Kimon 24 Apr 2012 at 2:57 am

    •In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?
    Crowding out of private investment is not a problem during a recession because chances are during a recession there are not enough people to buy stocks and fund a company. Also, corporations will probably try to reduce their investments since there is not enough demand for their product. However, in the long-run crowding out will be a problem when there is increased government spending because too many of the investments Increased government spending is more likely to crowd out private investment in the long-run, but in the short-run it is likely to be helpful.
    •Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
    The government borrows from the American people through a process of government bonds. People buy bonds and invest in them just as they would stock in the hope that these bonds will result in greater wealth later on. During a recession people’s greatest hope is actually to invest in the bonds since stocks are not doing well and there are no other forms of investments that can hope to be beneficial.
    •Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.
    Fiscal stimulus in the short-run will probably lead to a decreased growth in the long-run. In the short-run government intervention through bonds and deficit spending will aid the corporations. However, in the long-run much of the people’s money will be tied up in the bonds and actually hinder the private investments that could have gone to the corporations. This will result in slower economic growth in the long-run.

  16. azacharjaszon 11 Apr 2013 at 9:37 am

    ? In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

    I think that it is a problem because the government borrows large amounts of capital; they probably will increase interest rates. Higher interest rates discourage individuals and businesses from borrowing money, which reduces their spending and investment activities. With higher interest rates the people will try to save money and thus the consumption and the investments will decrease leading to a decrease in the aggregated demand.

    ? Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?

    The government can borrow the money from the people that put their money in the bank. Also the government could use bonds to borrow money from the people. In each of the cases the government will have to pay interest rates.

    ? Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

    I think that it will cause an increase in the GDP in the short run, so the economy will experiment an economic growth but in the long run consumption and investment will decrease leading to a decrease in the economic growth. I believe that if the borrowed money is from the banks then the effect would be more harmful in the long run than if the money is borrowed in form of bonds.

  17. azacharjaszon 11 Apr 2013 at 9:45 am

    # Samantha Kim
    I agree with you that effect of crowding-out will be positive in the short run but in the long run the effect will be negative. It is difficult to predict if and the end the consequences will be positive or negatives but it is probable that the situation in the future will be even more negative than now. Also we have to remember that if the government borrows too much money then he will have problems to pay the interest in the future and he will have to borrow more money entering in a circle.

  18. jvanderelst123on 13 Apr 2013 at 6:05 pm

    In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?
    – I think that crowding out is not a problem during the short term because it only mainly effects the economy in the long term. Its not a problem in the short term because no one was going to invest anyway in a failing market at the time therefore it wouldnt really have an effect on the economy. However in the long run it will be a problem because there will be an increase in government spending , due to people over investing in governmnet spending, and therefore this will crowd out private spending.

    Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
    -The bank can either borrow investments or bonds from the bank. But in any case they will still have to pay taxes.

    Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss
    -It will most definitely lead to a decrease in growth in the long run due to the main fact that since everyone in the recession has invested in government spending, in the future governmnet spending will “crowd-out” private spending and therefore if there are no investments into the firms economic growth will decrease.

  19. jvanderelst123on 13 Apr 2013 at 6:07 pm

    azacharjasz:
    I disagree with your first reply as it clearly states in the article that in the short run it doesnt really effect the economy in a recesion, but it actually has more of a long run effect on the economy due to government spending crowding out private spending.

  20. mlayurovaon 13 Apr 2013 at 8:42 pm

    In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

    In my opinion, overall, the crowding-out creates some problems. First, notoriously, as government borrows more money, the interest rates go up, thus reducing the private investments. As result, the total output changes only a little, because of the higher interest rates, people will tend to save more money, therefore decreasing their consumption.

    Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
    Here is how Treasury securities – such as savings bonds – generally work. People lend money to the Government so it can pay its bills. Over time, the Government gives that money, plus a bit extra, back to those people as payment for using the borrowed money. That extra money is “interest.” (Source: http://www.treasurydirect.gov/kids/what/what_borrow.htm)

    Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run?
    In the short-run it will lead to increased economic growth, but in further future in the long-run the economic growth will decrease, because of the reduced investments and finite amount of government spendings.

  21. mlayurovaon 13 Apr 2013 at 8:45 pm

    @azacharjasz
    I found very interesting the point you made in the third question “I believe that if the borrowed money is from the banks then the effect would be more harmful in the long run than if the money is borrowed in form of bonds.”

  22. ywang2on 15 Apr 2013 at 4:21 pm

    I think that it is a problem because as government borrows more and more money, the interest rate will go up because the government and the private firms are compete with each other and after interest rate raise, the amounts of investment by companies will decrease, so even the expenditure by government increase, but the outcome in total will likely to be the same.

    The government can borrow the money from the people by borrowing money from the bank that people put in. or government can borrow money direct from people, for both cases the government will pay the interests.

    the GDP will increase in the short run, but in a long run it will decrease, because the government will eventually running out of money and puls the increase in interest rate, the investment will decrease too.

  23. ywang2on 15 Apr 2013 at 4:25 pm

    # azacharjasz
    I agree with # mlayurova, the point you made for long run for borrowing from bank by government will be more harmful is very interesting, I’d never thought of it before.

  24. Paul Jeffrieson 16 Apr 2013 at 12:20 am

    In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

    Crowding out cannot literally be a problem “during” a recession, as recessions are normally considered to be short-term crises, whereas the “crowding-out of private investment” is something that takes place in the long run. So, literally, no, it is not a problem “during” a recession, but it is most definitively problematic further along down the road, as a result of the stimulus spending. In the short run, government run deficits will theoretically lead to economic growth, reduced unemployment, and increase national output. At the same time though, it is important to note that for stimulus to work, the short run benefits must outweigh the long-term possibilities, and this requires a well managed stimulus which will ensure that none of the money is wasted, as the more that you borrow for the stimulus, the greater the risk of the crowding-out effect later on down the road. In summation, yes, crowding-out is a problem that can result from a recession in that many governments will decided to form stimulus packages in order to attempt to dig their way out of the recession, and if these stimulus plans are not well organized, targeted, and efficient, then the crowding out problem is a legitimate possibility.

    Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?

    In order to run a budget deficit or produce any sort of stimulus plan, a government must borrow money, either from abroad in the form of government loans, or from the American people. In the case of borrowing from the American people, this traditionally means the selling of government bonds. At the same time, we can take this to mean tax increases as well, as sometimes, in order to pay for a stimulus, the government must increase revenue by raising taxes in the short run, which might be perceivable as borrowing from the American people, as long as there is the assurance that the funds from the tax increase will be re-invested or re-funded at a later date.

    Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

    I don’t think that we can see whether or not the fiscal stimulus in the short-run will lead to a definitive decrease or increase in growth in the long-run, as we have not yet seen it first hand. The article mentions very specifically that the long term fiscal policies won’t take effect until 2019, which means that those responsible will be long gone out of office, and safe from all responsibility. The result of the stimulus has to do with the way in which the funds for the stimulus were allocated, as this will determine the long-run result of the stimulus. There is the chance that fiscal stimulus could yield long term growth because of the benefits that it has in the short run which could yield high investor confidence and lead to further economic growth, but at the same time there is also the possibility that it could lead to decreased growth in the long run because of the aforementioned crowding-out effect. The deficit spending will provide incentives for the purchase of government bonds that will lead to more people wanting to buy them. This, in turn, will decrease the amount of capital being used in the form of private investment, and when private investment drops, so too does economic growth. All of this will lead to a decrease in growth in the long run, which is what we risk whenever we implement stimulus as a nation.

  25. Paul Jeffrieson 16 Apr 2013 at 12:26 am

    @jvanderelst123

    I agree with you in everything that you said. You are entirely right about the long term problems that arise from stimulus, and I think that practically, as in in terms of real life application, stimulus will always lead to long term sluggish growth because of the crowding-out effect. I argued for the possibility that a stimulus package could in fact lead to long term growth if implemented correctly, but I recognize and want to make known that such a situation is very rare as it requires an extremely efficient and well organized stimulus.

  26. joana wanderleyon 16 Apr 2013 at 1:27 pm

    In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?

    I think it depends, it will definitely help government input and therefore give it more opportunity to use this money for public benefits. However, in a capitalist economy private investments have to flourish in order to have growth and competition. Therefore it is a problem during recession as it does not assist the economic growth itself.

    Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?

    By collecting both direct and indirect tax. They can also claim the money from corporation tax, excise duties, interests in things such as loans. Etc.

    Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

    I believe it will benefit the long run until a certain point. The government has to let a company grow but with it’s “leashes”. Therefore, the fiscal stimulus will “breed” these companies and guide them. When they flourish they are entitled to claim a percentage of the profit. However, if it is a private economy and therefore too much government intervention will hurt the economic growth.

  27. rpilleon 16 Apr 2013 at 8:20 pm

    1. In a recession crowding out could become a problem. The government will borrow more money from the banks, which increases the investment rate. If this happens people will rather save their money instead of investing it. This causes a decrease in consumption and therefore a decrease in GDP.

    2. The government cannot directly borrow money from the private sector. However when people put their money on a bank account the government can borrow money from the bank. The government would eventually borrow money from the people and not from foreign countries.

    3. I think that fiscal policies will lead to an increased growth in the long run. Education and health care will improve and people will have a better basis to start with.

  28. mroxburghon 20 Apr 2013 at 8:11 pm

    1. I think that during a recession, crowding out is a problem. When government borrow money, the interest rates will rise. This will cause individuals to want to save their money and not to spend and invest it because the interest rates are much higher. So, crowding out does not help the economy that much.

    2. There are a few different ways in which the government borrows money from the Private sector, Americans. Firslty, they could increase taxes. This will not only increase the Governments money income but this will also discourage spending on behalf of the americans due to the higher prices and less income. Also, the government sells government bonds to Americans to borrow money.

    3. I think that in the long run, the economic growth will decrease because much of the peoples money will be tied up in Government bonds. Also, because of the reduced investments, the economic growht will decrease.

  29. mroxburghon 20 Apr 2013 at 8:14 pm

    #rpille – But don’t you think because of the negative effects such as the lack of investment on behalf of firms, and individuals that this will lead to a decrease in economic growth in the long run?