A Flow of Funds Analysis of Crowding out

Abstract

The theoretical basis for use of debt-financed government expenditures as a means of economic stimulus is the Keynesian multiplier analysis. Advocates argue that increases in debt-financed government expenditures cause repeated rounds of private expenditures and thereby a multiple expansion of total expenditures. Opponents argue that for a given money stock, debt-financed government expenditures displace private expenditures so that increases in total expenditures are negligible once the multiplier process is complete, i.e., government expenditures crowd private expenditures.' The theoretical debate over crowding out has a long history. With exceptions [1; 2; 3; 9; 23], important aspects of the debate can be explained within various extensions of the traditional IS-LM model [4; 5; 6; 11; 13; 14; 24; 26; 28; 29; 30; 32]. Although the empirical evidence is mixed, the weight of the evidence lends support to the real crowding out hypothesis over time. Fromm and Klein's simulation results [17] show the implied government expenditure and tax multipliers for a number of the large econometric models, e.g., Warton Mark III and Bureau of Economic Analysis-Commerce Department. The results from the majority of the models surveyed lend support to the existence of real crowding out in the long run. The time period of real crowding out depends on the lag structure of each model. The evidence does not lend