A Modern Money Perspective on Financial Crowding-out

The withdrawal of discretionary fiscal stimulus and a renewed emphasis on institutional and 'self-imposed' budgetary constraints are evidence that the imperative of fiscal sustainability and sound accounting fundamentals continue to drive fiscal policymaking within many advanced economies. To buttress the urgency for fiscal sustainability, neo-liberals often draw upon financial crowding-out theory. Despite an extensive literature, empirical applications are often misspecified due to their failure to account for different institutional arrangements. However, the policy responses of national governments to the Global Financial Crisis have highlighted the institutional disparities, presenting a unique opportunity for a rigorous empirical investigation. This paper develops panel vector error correction models for both sovereign and non-sovereign economies over the period 1999 to 2010 to examine financial crowding-out. The empirical evidence reveals crowding-out effects in non-sovereign economies, but not within sovereign economies.