Evaluating Fiscal Policy - the Crowding-out Effect - part 1

Previous lessons on fiscal policy have explored the multiplier effects resulting from increases in government spending and decreases in taxes. This video will examine the possibility that expansionary fiscal policy, when financed by a budget deficit, will actually result in less private sector spending, i.e. "crowding-out" of the private sector. When governments borrow to pay for a stimulus, this drives up borrowing costs for households and firms, reducing the amount of consumption and investment. The crowding-out effect reduces the effectiveness of expansionary policies aimed at increasing the total demand for a nation's output.
Want to learn more about economics, or just be ready for an upcoming quiz, test or end of year exam? Jason Welker is available for tutoring, IB internal assessment and extended essay support, and other services to support economics students and teachers. Learn more here! econclassroom.com/?page_id=5870

[@sooyahn]

you helped me get an A on my macroeconomics midterm! Now I'm back for my final exam :)

[@ace543]

I can't tell you how much this has cleared things up for me! Thank you so much for adding this.

[@linhtrangpham1995]

Amazing!!! I've watched some videos explaining crowding out effect, but honestly, only after watching ur video could I fully understand the nature of this effect. :D Thank u so much!!!!!

[@JasonWelker]

Good question. The fiscal cliff should do the opposite of crowd out investment, since it will reduce the US deficit and the government will need to borrow less, leaving more funds in the private sector. However, if it also causes the US economy to enter a recession, lenders may demand higher returns on US bonds, which could, ironically, drive up interest rates anyway. But since crowding out is the result of deficit spending, tax hikes and spending cuts should have the opposite effect.

[@SodaQuasar]

I like this video. very clear and easy to understand.thank you very much!

[@AlokJadva]

This was so expertly explained and each logical chain was laid out, making sure any gaps I had in my knowledge (such as the context where the government becomes a borrower in the LFM). Although, I would like to know more about this mechanism. The government doesn’t just go into a bank and ask for a loan right? Don’t they borrow through bonds? Need to research into this further

[@jurijunichi]

Thanks for the video. It helps tons. :D BTW, is it weird to ask about what the title of the beginning song is?

[@Iguardoradstack]

excellent video, very helpful!

[@rekhabhatt6829]

What happens to crowding out when IS curve is vertical. Is there any crowd out as Investment is interest inelastic. Please do reply sir😊

[@NehaSharma-bt2bj]

Is the interest rate over there is interest rate on borrowings or rate on savings?

[@ayuchandraasri4679]

is there any crowding-out effect on fiscal cliff in US nowadays? (please give me the explanation as well)

[@shiathui]

Thanks for the video!:)

[@denizacar9025]

Can someone explain to me briefly why the multiplier is smaller than 1 when there is crowding out. I thought that crowding out would just reduce the multiplier e.g from 4 to 3, not make it less than 1??

[@varshaarora6962]

what is fiscal cliff ? could u please explain it to me

[@doganfil92]

would crowding in just be the exactly opposite effect?

[@JasonWelker]

Jason, check out my website: The Economics Classroom (google it) The videos are organized by topic there. When I refer to a previous video, I am speaking to students who are subscribers to my website. I also have playlists organized by topic here in KZbin if you visit my channel page.

[@FromBehindTheBoard]

Ok, a few things don't make sense to me here. First of all, what is the distinction between money saved vs not saved? For instance, I keep all my money in my bank account. Some amount smaller than the total leaves and enters frequently, but it's all in the same place. Plus, if I spend some money, it usually just gets transferred to somebody else's account, who's now in the same situation. So shouldn't "money saved and available for lending" just be all the money supply all the time, except for physical cash? Plus, say I use some savings and buy somebody's bond. Aren't they going to then spend this money, which very quickly makes it back into somebody's savings? It seems to me that the savings pool is basically infinite, because all the money borrowed becomes money saved. And since the demand for savings can be extinguished but the supply cannot, it seems like the interest rate should fall to zero (or perhaps arbitrage to an interest rate exogenously set on government bonds). Right?

[@wcwaugh]

Why do you assume that the money is going to be spent? Savings can imply just that, people keeping a larger percentage of cash in the banks or on their person, and reducing their lifestyles by buying less. Remember that savings is by Keynes considered a leakage. Growth is attained through spending/capital formation (Keynes) and anything that slows this spending is going to harm growth. The animal spirits also come into play, if consumer confidence decreases then consumers will not want to borrow no matter how low the interest rates and RGDP will decrease. If the demand for savings is extinguished, are you saying no new projects/investment is happening? If growth isn't happening then aren't we in essence eating our capital (consuming our seed corn). How long could that continue? If the interest rate falls to zero, are you saying that money is free? Money is useful tool but it represents resources and if the price of money is zero then it implies there is no competition for its use. Let me see if I can say this better, You seem to be saying that as money is always somewhere that that implies it is everywhere and since money is everywhere it would be treated like a free good (like air). If money is free then of what use would it be? You can't eat money. Does scarcity factor into this equation. Perhaps to much coffee this morning.

[@FromBehindTheBoard]

I don't think you're getting me quite right. Let's say that "saving" = keeping money in my bank account rather than spending it. The problem with this is that if I personally make the decision to spend rather than save, this in no way affects the total amount of money saved, because it just transfers my savings to somebody else. So the amount of money available for loans is always all of it, regardless of how much demand for lending there is, or what the interest rate is. So, it seems like the only possible situations are that there's always more money available for lending than is desired to be borrowed, in which case the interest rate would fall to near-zero (like shifting a supply curve far out to the right of the demand curve), or there's always less money available than is desired to be borrowed, in which case we have a liquidity crisis and the government steps in to make emergency loans.

[@wcwaugh]

I think, I get your point, that spending is someone else's income and they deposit it in banks where it is loaned out and spent and then funnels into someone else's bank account as their income. Rinse, repeat. I get it. You say, "there's always more money available for lending than is desired to be borrowed or there is always less money available than is desired to be borrowed". I would say there is a third option, the amount of cash doesn't really matter. If there is less cash than needed the price to borrow increases but so does everyones purchasing power of the each dollar they earn as (prices fall). If there is more cash,banks will lower rates to entice people to take out loans and the purchasing power of everyone is eroded as that excess cash pushes prices higher (inflation). My point (I think) is that there is always at any point in time a fairly set amount of cash available, but a fluid amount of people willing and able to get a loan. This lack of available cash isn't a liquidity crisis as the price to get the cash out of the bank is flexible depending on the demand which again, depends on the price. The amount of cash in the whole system is controlled/ manipulated by the FED. Again, the total amount of cash doesn't matter, what does is the marginal demand which is directly affected by the expected/unexpected interest rate which is affected by the amount of cash the FED releases into the economy and the confidence the public has in the future. All of these things seesaw back and forth, supply and demand of savings versus the production of goods and services with the government stepping in to fine tune the effects. I know need a nap,, this has been fun. C

[@FromBehindTheBoard]

I don't think your third option makes sense. Prices are determined by aggregate supply and demand, not the quantity of money lying around. If there's more money available to be lent than money desired for borrowing, the interest rates will fall towards zero (at least short-term ones would), but that only indirectly affects the amount of investment and consumption spending there is, so it may or may not have an effect on prices depending on how sensitive that spending is to interest rate changes (and the data I've seen suggests the answer is "very little") and depending on how much slack/idle capacity there is on the supply-side.

[@wcwaugh]

Price of money (Interest Rate) is directly affected by the supply of loanable funds which is directly controlled by the FED. They print it. Well actually the Treasury prints it but the FED is in control of how much is printed. We aren't talking pidly amounts we are talking billions of dollars a month sometimes, the FED buys bonds on the open market, this puts billions of dollars into the hands of citizens who deposit it in their banks (supply of loanable funds increase) and spend. Consumption increases and Investment increases and therefore Aggregate Demand (RGDP) increases. Why would the supply of tomatoes affect the price of tomatoes but the supply of money wouldn't affect the price of money?

[@Phazratali786]

nice sir sir can make any vedio on Crowding-in Effect. plz REGARDS ; HAZRAT ALI

[@morenamatema6144]

exactly,thats what im here for,it seems that one no one wants to touch it

[@quazarfire]

making me nervous by Brad Sucks