Crowding-Out, Reaganomics and Monetary Policy

Abstract

The size of the collective sector and its impact on the market sector are still crucial issues in the design of economic policy in industrial countries. Rapid growth of the collective sector is held responsible for a decrease in private activity in the past and hopes exist that a reduction of the burden of collective activity will revitalise market development. Crowding-out of private activity used to be mainly associated with interest rate increases caused by government borrowing, but with less high interest rates in the last years the discussion tends to shift to the impact of average and especially marginal tax rates. In as far as economic agents do not identify current taxation, and see the latter as equivalent to current borrowing with future taxation, the direct impact of additional government spending obviously depends on the way it is financed. Therefore both crowding-out through increased borrowing and crowding-out through increased taxation are potentially interesting. A similar conclusion holds for the reverse case of “crowding-in”. The way of financing identifies only the major impact channels however, as both borrowing and taxation can take different forms, and financial and other conditions that accompany changes in government activity may also differ. From a macroeconomic point of view two types of mechanisms are of particular importance with respect to crowding-out: the way monetary policy reacts to financial and other conditions and the endogenous component of the collective sector, in particular the response of social security benefits and premiums to changes in private activity and their ultimate burden.