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March 29, 2024, 04:48:06 pm

Author Topic: 'Crowding out' and 'crowding in'  (Read 1190 times)  Share 

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costargh

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'Crowding out' and 'crowding in'
« on: July 19, 2008, 08:38:06 pm »
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I can't get my head around the concept of 'crowding out' and 'crowding in'.
Anyone?

Eriny

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Re: 'Crowding out' and 'crowding in'
« Reply #1 on: July 21, 2008, 10:13:48 am »
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Directly taken from the notes I wrote last year (which I think were slightly plagerised from wiki):
Crowding in is a situation in which the actions of the government result in an increase in market participation by the private sector.
Crowding out is a situation in which the actions of the government result in a decrease in market participation by the private sector.
If increased government borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher "price", the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out. The weakening of fixed investment and other interest-sensitive expenditure counteracts to varying extents the expansionary effect of government deficits. More importantly, a fall in fixed investment by business can hurt long-term economic growth of the supply side. Crowding out is most serious when an economy is already at potential output or full employment. Then the government's expansionary fiscal policy encourages increased prices, which lead to an increased demand for money. This in turn leads to higher interest rates and crowds out interest-sensitive spending. At potential output, businesses are in no need of markets, so that there is no room for an accelerator effect. More directly, if the economy stays at full employment gross domestic product, any increase in government purchases shifts resources away the private sector. This phenomenon is sometimes called "real" crowding out.
The government believes that in order for long term growth to be sustainable, they must not only minimise their own presence, they must do everything that they can to help the private sector get involved.  This is the process of crowding in, and it has been achieved via a number of strategies.  One of the main strategies that has been implemented is a change to the way in which fiscal policy operates.
In the early to mid 1990s, the government ran consecutive large budget deficits.  At the time it was argued that these outcomes were needed to stimulate the economy.  The Howard government adopted a different approach; very soon after the 1996 election, the budget returned to surplus.  Since that time a deficit has been recorded only once.  With no call on national savings to fund a deficit, the strain on the money supply is effectively eased.  The direct consequence of this is that interest rates can be both lower and more stable.  This allows participants in the private sector to borrow money with more confidence, and as a result investment spending increases.
Similarly, the act of running a surplus means that the government is not spending to support businesses that might not otherwise be viable.  Running a deficit means spending more money than is received in taxes.  By choosing the allocation of these funds, some firms are supported by the government.  As the investment spending switches to the private sector, only those firms which are viable in the long term will be supported.  Once again, this helps to achieve the goal of sustainable long term growth.

costargh

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Re: 'Crowding out' and 'crowding in'
« Reply #2 on: July 21, 2008, 04:38:10 pm »
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THANKS ERINY!!