CROWDING OUT

What is it? 

-A critique and flaw of Keynesian policies that are applied to fight a recession (expansionary policy).

Why does it happen?

-The policy of cutting taxes and raising spending will create a budget deficit.

So?

-The budget deficit must be funded and to do this congress orders the sale of US bonds.

This money comes from?

-Money comes from US citizens and companies and investment firms.

Therefore?

-Money that could be spent on consumption or used for private savings is now being used to buy bonds.

On the money market?

-This will cause the  money demand curve to shift outward.

On the loan-able funds?

-This will cause the supply curve to shift inward because the are not saving money privately anymore.

On both graphs?

-The nominal and real interest rate will increase.

Therefore, on the investment D graph?

-The increase in nominal and real interest rates will cause Ig to decrease.

Isn't this counterproductive?

-Yes.

Why do it?

-Fiscal policy supporters insist that gains in C and G will outweigh any loss in future Ig.

Why?

-C and G are greater than Ig and they are short run improvements. Ig is longer run and Keynesian don't worry about that. In the long run we are all dead.

Anymore?

-Yes, this is summarized on the aggregate model. The AD will move outward due to the increases in C and G and then "maybe" move inward due to the loss of Ig, but not as much as the increase. Therefore the economy improves.

COUNTER-CYCLICAL POLICIES: KEYNESIAN FISCAL POLICY VS. MONETARY POLICY