Crowding Out DeLong: A Clarification

February 7, 2010

by Mario Rizzo  

“What it [the total of stimulus-created or saved jobs — MR] doesn’t consider are the jobs lost due to the very policies that are “saving” jobs. Government can only spend what it takes from the private sector one way or another, either through taxation, borrowing, or the redistribution effects of inflation. For every dollar that government spends, there is one less dollar being spent somewhere else in the economy. The jobs that weren’t created because the private sector lacked access to capital due to increases in government borrowing should be offset against whatever jobs the stimulus supposedly is creating.”  Steve Horwitz.   

Brad DeLong says (in the comments below my previous post) that I got Steve Horwitz’s point about crowding out wrong and therefore my defense of Horwitz is inappropriate. Furthermore, then, I miss the importance of DeLong’s evaluation that Horwitz is incompetent.  

First, and most important, I did not intend my post to be primarily a defense of Horwitz and therefore an implicit criticism of DeLong in his criticism of Horwitz. (Got that, readers?)

I intended to say simply that (1) DeLong is wrong for not worrying about crowding out in its various dimensions; and (2) that someone who worries about crowding out, like Steve Horwitz, is therefore not clueless or worse.

I did not realize that DeLong considered Horwitz’s particular version or presentation of the crowding out idea as the evidence of his incompetence. I should have seen that.

Second, please keep in mind that Horwitz’s argument does not appear in a journal article but on the Nightly Business Report (NBR) blog of the PBS Network. This is journalism directed to non-specialists.

Third, let’s look at what Horwitz said. The “offending” sentences are quoted above. It is true that he simplifies the process. But you will note that, as a statement about the long run, it is not bad. Deficits now that ensure higher interest rates later are going to result in an intertemporal crowding out. Raising marginal tax rates (or allowing the Bush tax reductions to expire) will result in jobs lost, especially as they impact small businesses. If the Fed is unsuccessful in contracting the high-powered money it has created, there will be inflation.

But, quite honestly, I am not that interested in correcting Horwitz’s NBR blog posts. And I don’t really care whom Brad DeLong considers incompetent or engaging in economic malpractice.

My central purpose is to say: If you believe in crowding out – even if you simplify the argument for the general public – you are not thereby clueless.

Incidentally, I think that Bastiat’s general point about the seen and unseen is a very valuable lesson for the public to learn. When some consequences are hard to measure or hard to see, it doesn’t mean they are not there doing their mischief. I think Brad DeLong must agree with this.

12 Responses to “Crowding Out DeLong: A Clarification”

  1. Brad DeLong Says:

    You know, I really do not know what you think you are doing.

    For the record, this is what I wrote that excited your original post:

    If Horwitz were–think of it!–to actually talk to Christie Romer or Alan Krueger or Chris Carroll or any of the people who are trying to track the effects of the stimulus program on the economy, he would learn that they are keenly interested in “crowding out”–on how much private demand for goods and services that would otherwise be there isn’t there because of increased deficit spending. Even though they cannot see jobs that were never created, they nevertheless can count them–and are trying to do so…. When increased government deficits crowd out private economic activity, they do so in one of two ways:

    1. The government sells extra bonds to finance its deficit, reducing the price of government bonds–and their substitutes, private bonds, as well. Because private firms seeking to raise capital find that they must sell their bonds for less than they had expected (or get loans on worse terms than they expected), they cut back on their operations and their expansion plans.

    2. The government’s demand for goods and services leads the firms that provide those goods and services to hire extra workers. They thus bid up the wage–and other firms that would have produced goods and services find that it is no longer profitable to do so because the wage is higher than expected.

    In both these cases… we can see the price changes…. In the first case, we detect crowding out through the fall in bond prices and the rise in bond interest rates accompanying the non-creation of private sector jobs. In the second case, we detect crowding out through the rise in wages and the wage inflation accompanying the non-creation of private sector jobs.

    We haven’t seen any fall in government bond prices associated with the stimulus. We haven’t seen any rise in wage inflation associated with the stimulus.

    Romer and Krueger conclude that whatever crowding out is occurring is extremely weak, and cannot offset more than a trivial part of the surge in aggregate demand created by the stimulus.

    That there hasn’t been any wage inflation-induced crowding-out is, to me, not surprising: the fracking unemployment rate is ten percent, after all. The full-employment world of Bastiat is very very far away. And relative to the magnitude of excess supply in the labor market, the stimulus is simply not big enough to induce any wage inflation-based crowding out. So I am not surprised that there has been no wage inflation-induced crowding out: that is a normal and expected part of our empirical reality.

    That there hasn’t been any bond price fall-induced crowding-out is, to me, quite surprising. As I have said before, on June 29, 2007 there was $4.94T of U.S. federal government debt held by the public. Yesterday there was $7.85T. The U.S. government has issued an extra $2.91T of debt to the public in nineteen months. And the public has slurped it down–has been willing to hold it all in its portfolios at the same, nay at higher, prices than it was willing to do nineteen months ago.

    This extraordinary price elasticity of demand for U.S. Treasury debt is, to me, astonishing, terrifying, and unexpected–I expected bond price fall-induced crowding-out to be showing itself by now. It is not, however, surprising to some other economists–people like Paul Krugman, Jamie Galbraith, and the ghost of John Hicks, all of whom did predict this and whose views must now be given some extra respect. For that there has been no fall in bond prices as debt held by the public has exploded, and hence no crowding out from the expenditures funded by the debt explosion, is a part of our empirical reality–even though I find it a surprising part…

    So when you say that your “central purpose is to say: If you believe in crowding out – even if you simplify the argument for the general public – you are not thereby clueless…” my response is: I believe in crowding out. I said that I believe in crowding out. I am surprised that we don’t have any signs yet that it is occurring.

    So let me ask three questions:

    1. Just what the hell do you think you are doing in defending Horwitz’s claim that crowding out is always 100% in the short run?

    2. Are too lazy to read what I wrote before jumping to the attack?

    3. Are you so mendacious that you really don’t care how much you misrepresent the situation to your readers?

  2. Bill Stepp Says:

    Brad DeLong writes:

    “We haven’t seen any fall in government bond prices associated with the stimulus. We haven’t seen any rise in wage inflation associated with the stimulus.”

    Maybe the “stimulus” has been the stimulus that wasn’t. According to the WSJ this weekend, “Opinions Split on Job Creation” (p. A4), a recent CBO report says that the biggest effect on employment has been lower payroll taxes for businesses that hire new workers, and boosting spending on unemployed people. Meanwhile the unemployment rate ticked down from 10% to 9.7%, so maybe the economy is actually healing itself, albeit slowly thanks to things such as that ole debil regime uncertainty, and the tepid (but possibly growing) lending to small businesses from banks. Merchant funding purveyors and hedge funds have reported an uptick in demand for loans.
    As for the government bond market, demand has been robust with lots of buying by China still, among others. The Fed has worked hard to keep interest rates down.

    Meanwhile, Steve Horwitz has elaborated his original statement at the Coordination Problem blog.

  3. Mario Rizzo Says:

    My general response to some of the criticism that has been directed to me:

    “It obviously endangers the freedom and the objectivity of our discussion
    if we attack a person instead of attacking an opinion or, more precisely, a theory.”

    — Karl Popper

  4. Pietro M. Says:

    There must be something I’m missing in the “crowding out doesn’t matter” reasoning, because from the abysmal heights of my undergraduate degree in economics the it seems too much simplified.

    1. Interest rates are low (on government securities) because of monetary policy and flight to quality: I wouldn’t expect crowding out to be visible on those interest rates, but on the private sector’s investment profitability. The real economy has many interest rates: the bond market is the wrong one to consider. When everybody moves to low-risk assets, there can be a crowding out of productive investments (not shielded by the power to tax) and a fall in low-risk bond prices. Even without flight to quality, monetary policy can make every interest lower as long as inflation is under control: during deleveraging, this doesn’t come as a surprise.

    2. Gross profits (returns) in the private sector depends on the price margins between output and input goods: if there is crowding out, I expect a rise in input prices. Raw materials are skyrocketing, for instance. Real wages may be on the rise, given FRED data, at least up to a few months ago. Nominal wages are increasing even now.

    3. I believe however that the effect on wages is sample selection bias: low-skilled jobs are being destroyed and this increases average hourly earnings. However, it may also be the effect of crowding out: I don’t believe it only because with a 10% unemployment it is an unlikely scenario.

    4. Wages are not the only costs: raw materials and half finished goods are costs, too. They are on the rise, and wildly. Only capital equipment doesn’t rise: I don’t know about the definitions of these aggregates, but it’s exactly the behavior I would expect considering Austrian capital theory in case of production bottlenecks and crowding out.

    This said, I would look at wages as the only cost factor and I would look at interest rates in the presence of activist monetary policies: as far as I know, however, return rates are never considered in macroeconomic analyses.

    Probably Romer’s and Kruger’s analysis is more sophisticated than how I see it and these problems have been accounted for, I don’t know.


  5. In today’s Wall Street Journal, Glenn Hubbard addresses the issue of future crowding out. He offers an estimate that real GDP will be 4% lower than it would have been by 2012 under the present trajectory.

    http://online.wsj.com/article/SB10001424052748704041504575045250168889076.html

  6. Mario Rizzo Says:

    Yes, generally good article. But his proposals for correcting the spending problem look as if he has never spent time in DC (which, of course, he has) I think that the spending problem just has to play itself out. Nothing less than a major fiscal blowup will reform Washington. So I wait and watch.


  7. In the January 28, 2010 issue of the Financial Times, Carmen Reinhart and Kenneth Rogoff present the historical evidence on what follows in the aftermath of financial crises like the present (“Why we should expect low growth amid debt”). “Unless this time is different — which so far has not been the case — yesterday’s financial crisis could easily morph into tomorrow’s debt crisis.

    It is a complex argument that involves crowding out via rising inteerst rates and rising taxes to deal with debt and deficits. Debt crises that lead to sovereign default can come without warning.

  8. Bill Long Says:

    I commend all of you for wading into the morass that is trying to argue logically with Brad DeLong. Brad’s first (and often only) response to people who disagree with him is that they are “incompetent” or something similarly demeaning. He once called Allan Meltzer a “hack”, to which I posted in his comments, “It takes one to know one, Brad.” I stand by my comment.

  9. Corrigan Says:

    Rather than looking at Fed-monetized bond yields and overall wage rates (which have actually RISEN in a steep recession, Brad), our Keynesian polemicist might look at investment patterns in private industry instead.
    There he might notice that net capital investment per capita is at its lowest in the post-war record and that equipment ages are lengthening, while the inventory liquidation (which may only now be drawing to a close) has been both one of the most protracted and one of the deepest since the 1930s themselves.
    He might also look at the toll being exacted on higher-order industries paying note, for instance, to manufacturing (in the round) where the total number of hours being worked has fallen back to where it was before Pearl Harbor!
    Stimulus maybe crowding the exhaustive outlays of zombie car-makers, merchants-of-death, state pencil-pushers, and Wall St corporate welfarists INTO the economic accounts, but it is surely also crowding forward-oriented, potentially productive, business spending OUT, even as we speak

  10. Gene Callahan Says:

    “Just what the hell do you think you are doing in defending Horwitz’s claim that crowding out is always 100% in the short run?”

    Dear, Profesoor DeLong, are you so lazy, incompetent and mendacious that you need to just make things up and put them in your opponents mouths? I just read Horwitz’s piece, and nowhere in it does he make the claim you accuse him of making.

    Projection is not just a river in Egypt, Brad.


  11. I do not follow labor market data. But I just listened to an anlysis that those who do should follow the US Treasury’s data on Current Witholding of Payroll Taxes. They are real-time data, which purportedly show a weaker jobs and salaries market than do BLS data.

    I leave it to others to sort this claim out.

  12. Matt Says:

    An additional point left out of all this discussion is the difference in returns on government spending vs. private spending. If government crowding out is 50/50, then it would need to have at least 50% as high returns as the private sector. How large is crowding out? Impossible to know, but I’d guess its something like:

    % of Resources Employed.

    So if the economy is at full employment, crowding out is 100%. If economy is at zero unemployment, crowding out is 0%.


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