Re: Crowding Out Hypothesis

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

There is no future debt burden when most of the debt is held domestically because it just amounts to a redistribution from taxpayers to bond holders.  However, there is a future domestic burden if interest payments are made to foreign debt holders--since future GDP is reduced.

Lonnie K. Stevans
acslks@xxxxxxxxxxx

>>> William F Hummel <wfhummel@xxxxxxxxxxx> 08/13/03 01:06PM >>>
Lonnie K. Stevans wrote:

>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.

I agree that there is no evidence to support the thesis that interest
rates, real or nominal, automatically increase as a result of
government deficit spending.  However I was using the expression
"crowding out" in the context that is implicit in the quote by
Volcker:

"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."

It seems to me that the issue is whether government deficit spending
itself replenishes the loanable funds used to buy government bonds.
If not, then there would clearly be a crowding out effect that would
reduce private sector spending and investment.  My contention is that
there is on average a reciprocal flow of funds between the government
and the private sector due to deficit spending.  While there can be
transient shortages in loanable funds, there is no secular component.

As for increasing interest payments to foreign buyers of government
debt, I see no negative effect there.  The interest is paid in US
dollars which can only be spent on dollar-denominated assets.  The
purchase of that government debt represents an investment in the US
that is balanced against the goods and services previously sold to the
US.  The interest payments are simply a part of the present value of
that investment.

William F Hummel