Crowding Out or Crowding in? The Economic Consequences of Financing Government Deficits

78 Pages Posted: 27 Apr 2000 Last revised: 2 Jan 2002

See all articles by Benjamin M. Friedman

Benjamin M. Friedman

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: October 1978

Abstract

The prevailing view of the economic consequences of financing government deficits, as reflected in the recent economics literature and in recent public policy debates, reflects serious misunderstandings. Debt-financed deficits need not "crowd out" any private investment, and may even "crowd in" some. Using a model including three assets - money, government bonds, and real capital - the analysis in this paper shows that the direction of the portfolio effect of bond issuing on private investment depends on the relative substitutabilities among these three assets in the public's aggregate portfolio. Since the all-important substitutabilities that make the difference between "crowding out" and "crowding in" are determined in part by the government's choice of debt instrument for financing the deficit, this analysis points to the potential importance of a policy tool that public policy discussion has largely neglected for over a decade - debt management policy. When monetary policy is non-accommodative, within limits debt management policy can take its place in augmenting the potency of fiscal policy, or in improving the trade-off between short-run stimulation and investment for long-run growth.

Suggested Citation

Friedman, Benjamin M., Crowding Out or Crowding in? The Economic Consequences of Financing Government Deficits (October 1978). NBER Working Paper No. w0284. Available at SSRN: https://ssrn.com/abstract=226650

Benjamin M. Friedman (Contact Author)

Harvard University - Department of Economics ( email )

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