Why Federal Borrowing Does Not Crowd Out Private Investment Now...Again

Lately we are hearing various commenters worry that the recent rise in Treasury yields suggests some fundamental market insight that we are on a wrong course. But they are forgetting what is normal. Current rates are more a return to normal. We are a ways yet from rates that are high enough to be threatening. Worrying about these more normal rates is similar to noticing a light breeze after an period of calm, and rushing to close the storm shutters.

Martin Wolf correctly lays out the current situation in a recent FT column.

...Economists who believe in “Ricardian equivalence” – after the early-19th-century economist David Ricardo – argue fiscal policy is ineffective, because households will offset any government dis-saving with their own higher savings.

Economists disagree fiercely on these points. My approach is “Keynesian”: in extreme moments, the excess of desired savings over investment soars. Again, monetary policy, while important, becomes less effective when interest rates are zero. It is then wise to wear both monetary belt and fiscal braces.

A deep recession proves there is a huge rise in excess desired savings at full employment [Hal here: I'd word this more clearly -- simply that people want to save a lot now and for now that is excess savings], as Prof Krugman argues. At present, therefore, fiscal deficits are not crowding the private sector out. They are crowding it in, instead, by supporting demand, which sustains jobs and profits.

Readers of this blog will already know this central point made here back in January:

...crowding out [which itself leads to higher interest rates]...certainly does happen when an economy is running at or near full steam, so that resources (machines, workers, money) are being fully or almost fully utilized, so that all new output of the economy requires new investment dollars. In that situation, private investment competes for those new dollars with government. But when an economy has much slack, as ours does now, so that more money is sitting in money market accounts and short term treasury bills, there is plenty of available money for government borrowing and investing, and still plenty left for any private borrowing and investing the private sector chooses.

Still, it seems we need to be reminded of the fundamental situation, and it's nice to hear the same central point from another writer, in different language, for clarity.