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Crowding Out Or Crowding In? The Economic Consequences of Financing Government Deficits


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  • Benjamin M. Friedman
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    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.

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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0284.

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    Date of creation: Oct 1978
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    Publication status: published as Friedman, Benjamin M. "Crowding Out or Crowding In? The Economic Consequences of Financing Government Deficits." Brookings Papers on Economic Activity , Vol. 3, (1978), pp. 593-654.
    Handle: RePEc:nbr:nberwo:0284

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    Cited by:
    1. Arze del Granado, Javier & Gupta, Sanjeev & Hajdenberg, Alejandro, 2013. "Is Social Spending Procyclical? Evidence for Developing Countries," World Development, Elsevier, vol. 42(C), pages 16-27.
    2. Sanjeev Gupta & Alejandro Hajdenberg & Javier Arze del Granado, 2010. "Is Social Spending Procyclical?," IMF Working Papers 10/234, International Monetary Fund.


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