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Do Tax Cut And Spending Deficits Have Different Crowd Out Effects?

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  • John J. Heim

    () (Department of Economics, Rensselaer Polytechnic Institute, Troy, NY 12180-3590, USA)

Abstract

The crowd out effects of government deficits are tested by adding deficit variables to consumption and investment models which extensively control for other factors. Separate variables are added for deficits resulting from tax cuts and spending increases. Effects are calculated for recession and non-recession periods, and compared to models with average crowd out effects for the whole business cycle, and models without crowd out. Test results indicate 1) deficits crowd out private consumption and investment, are statistically significant, and explain substantial variance. They predict “IS” curve coefficients better than no crowd out models. In both recessions and non-recessions, government spending deficits were associated with complete crowd out, leaving no observable net stimulus effect. Tax cut deficits resulted in more than complete crowd out, resulting in net negative economic effects. Both findings are consistent with crowd out theory. Crowd out was found to have roughly equal effects in recessions and non-recession periods. Results are corroborated by independent testing of borrowing data; total declines in private spending were about equal to total declines in borrowing associated with deficits. Financing deficits by monetary expansion may avoid some crowd out problems, but only if the expansion is in the savings components of M2, and occurs in years immediately before the deficit is incurred, limiting its practicality. Foreign borrowing, to supplement domestic savings, can reduce the potential for crowd out.

Suggested Citation

  • John J. Heim, 2011. "Do Tax Cut And Spending Deficits Have Different Crowd Out Effects?," Rensselaer Working Papers in Economics 1104, Rensselaer Polytechnic Institute, Department of Economics.
  • Handle: RePEc:rpi:rpiwpe:1104
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    File URL: http://www.economics.rpi.edu/workingpapers/rpi1104.pdf
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    References listed on IDEAS

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    1. John J. Heim, 2008. "The Consumption Function," Rensselaer Working Papers in Economics 0805, Rensselaer Polytechnic Institute, Department of Economics.
    2. Andrew Mountford & Harald Uhlig, 2009. "What are the effects of fiscal policy shocks?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(6), pages 960-992.
    3. John J. Heim, 2010. "The Declining Exchange Rate: Impact On The U.S. Economy 2000-2009," Rensselaer Working Papers in Economics 1004, Rensselaer Polytechnic Institute, Department of Economics.
    4. John J. Heim, 2010. "Do Government Deficits Crowd Out Consumer And Investment Spending?," Rensselaer Working Papers in Economics 1005, Rensselaer Polytechnic Institute, Department of Economics.
    5. Cebula, Richard J, 1978. "An Empirical Analysis of the "Crowding Out" Effect of Fiscal Policy in the United States and Canada," Kyklos, Wiley Blackwell, vol. 31(3), pages 424-436.
    6. John J. Heim, 2009. "Demand For Durable Goods, Nondurable Goods And Services," Rensselaer Working Papers in Economics 0906, Rensselaer Polytechnic Institute, Department of Economics.
    7. Davide Furceri & Ricardo M. Sousa, 2009. "The Impact of Government Spending on the Private Sector: Crowding-out versus Crowding-in Effects"," NIPE Working Papers 6/2009, NIPE - Universidade do Minho.
    8. William G. Gale & Peter R. Orszag, 2004. "Budget Deficits, National Saving, and Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(2), pages 101-210.
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    Cited by:

    1. Agnello, Luca & Castro, Vítor & Sousa, Ricardo M., 2012. "How does fiscal policy react to wealth composition and asset prices?," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 874-890.
    2. Agnello, L. & Furceri, D. & R.M, Sousa., 2011. "Fiscal Policy Discretion, Private Spending, and Crisis Episodes," Working papers 354, Banque de France.
    3. Luca Agnello & Vítor Castro & Ricardo M. Sousa, 2012. "Are there change-points in the likelihood of a fiscal consolidation ending?," NIPE Working Papers 18/2012, NIPE - Universidade do Minho.
    4. Luca Agnello & Davide Furceri & Ricardo Sousa, 2013. "Discretionary Government Consumption, Private Domestic Demand, and Crisis Episodes," Open Economies Review, Springer, vol. 24(1), pages 79-100, February.
    5. Luca Agnello & Ricardo M. Sousa, 2011. "Fiscal Consolidation and Income Inequality," NIPE Working Papers 34/2011, NIPE - Universidade do Minho.
    6. Luca Agnello & Ricardo M. Sousa, 2014. "How Does Fiscal Consolidation Impact on Income Inequality?," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 60(4), pages 702-726, December.

    More about this item

    JEL classification:

    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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