Re: Crowding Out Hypothesis

["Lonnie K. Stevans" <acslks@xxxxxxxxxxxxxxxxx>]

It seems that you are confusing "crowding-out" with another issue that deals with future debt burden.  "Crowding-out" occurs when government involvement in the debt market raises interest rates and thus "crowds-out" private spending.  From what I understand, there has not been much empirical evidence for this.  The issue of debt being held by foreign lenders becomes a problem in the future when resources must be sent externally to make interest payments.

Lonnie K. Stevans
acslks@xxxxxxxxxxx

>>> William F Hummel <wfhummel@xxxxxxxxxxx> 08/12/03 10:46PM >>>
Following is a passage from Volcker's "Changing Fortunes" (1992)
regarding the huge budget deficits of the Reagan era:

"The United States was running a budget deficit of more than 5 percent
of the gross national product.  The American people were simply not
saving enough money to buy all the Treasury bonds as well as to buy
new homes and invest on their own.  So we were forced as a country to
rely on foreign lenders, and to do that we had to maintain their
confidence as a place to keep their money."

What seems to be missing in the crowding out hypothesis implicit in
Volcker's comments is the recognition that the Treasury spends the
newly borrowed funds right back into the private sector.  The borrowed
funds don't disappear into a black hole.  There is a redistribution of
financial assets due to government spending, but proceeds of the
borrowed funds for deficit spending will return in due time to the
loanable funds category, other things equal.

It seems to me that crowding out in financial terms is at most a
temporary phenomenon, and is not a function of foreign lending.  For
example, if the Treasury puts too large a slug of new debt up for sale
at one time, that could result in a dip in domestic loanable funds
that would squeeze the other markets.  However the Treasury normally
avoids that by borrowing in relatively small amounts at frequent
intervals rather than large amounts infrequently.

There is a balanced reciprocal flow of funds between the Treasury and
the private sector on average.  Since revenues cannot be synchronized
with spending, the Treasury buffers the short-term imbalances in its
Treasury Tax and Loan accounts in commercial banks.  Those funds count
as reserves of the banking system, and thus do not have a first order
effect on the aggregate reserves.

In my view, crowding out is a real, not a financial phenomenon.  It
occurs only when the government calls for manpower or goods and
services in excess of the demand by the private sector.  Those
instances are few and far between.  I can't recall any such crowding
out since World War II when many goods were rationed, and manpower was
in short supply because of the military demands.

William F Hummel