AN ECONOMY only has so much in the way of real resources. At a given moment, there are only so many people available to work and only so much capital that can be used in production. If an economy is operating at capacity and the government wants to expand what it's doing, say by going to war, it must begin utilising real resources that are already being deployed elsewhere. It can do this by borrowing. The increase in demand for capital will push up interest rates, making the private sector less interested in investing and freeing up capital resources for the government. Or it can hire away workers, pushing up wages, reducing private sector hiring, and freeing up the labour resources for the government.
These processes are generally called "crowding out", and they represent worrisome economic shifts. When expanded government activity generates increased interest rates, that's a sign that the activity is coming at the direct expense of private sector expansion, and society should think very, very carefully about the return to that increased government activity. It might nonetheless be worthwhile—defending the nation from attack would fall into this category—but in general it probably means that the government should find ways to reduce wasteful aspects of its demands on the economy.
But what if an economy isn't running at capacity? What if there are millions of workers sitting around without jobs and hundreds of billions in capital sitting around earning almost nothing in the safest securities firms can find? Well obviously, in that case, expanded government activity would not crowd out private activity. On the contrary, increased government demand should actually increase private activity, because the dollars spent by the government will be recycled as workers use their wages to buy private goods and services.
Now, one should be somewhat cautious in ramping up government spending. The increase should be temporary; as private sector activity ramps up, government spending should pull back. And one should be careful to minimise negative knock on effects (war is costly, etc). But generally speaking, crowding out isn't a problem when there is massive slack in the economy.
Casey Mulligan seems not to know this. Worse still, he seems willing to grasp at the most ridiculous examples to argue otherwise. Today, he says:
The Great Depression began in 1929 and lasted too long. Stimulus advocates tell us that the government spending surge that occurred as a result of our joining the war is the primary reason the Great Depression eventually ended.The chart below shows the civilian unemployment rate from 1929 through 1941. With the exception of the last 24 days of 1941, the United States was not at war during those years, and its real government purchases were less than a third of what they would be during the war. Yet the unemployment rate had already come down sharply by the end of this period.
This is already an embarassing performance by Mr Mulligan. First, "stimulus advocates" tell us lots of things, including that large deficits were working to increase output prior to the "recession within a depression" in 1938", that monetary policy is important, and so on. While America didn't officially enter the war until after the attack on Pearl Harbor, but American deficits began rising before that—as early as 1939. And by the end of 1941, the American unemployment rate remained arond 10%.
Thereafter, of course, it fell dramatically. By 1944, unemployment in America was essentially nil. Mr Mulligan complains about this:
Nor did wartime military spending expand the private sector. Many parts of the private sector shrank during the war precisely because the government was spending so much.
Mr Mulligan may not be aware of this, but during the Second World War, private economic activity was subject to strict rationing, and much of the manufacturing sector was mobilised for direct production of military equipment. I don't really know what more to say about this. If deficit spending in America were combined with strict rationing of consumer goods and orders that General Motors begin churning out tanks, then yes, I suppose private sector activity would contract.
Obviously, at some point fiscal spending will generate crowding out; America's current output gap isn't limitless. But American government spending is nowhere near the crowding out point, as evidenced by the rock bottom levels of yields on government debt (and the unemployment rate, and the estimated output gap, and levels of private saving).
So when people begin proposing new stimulus plans upwards of $5 trillion in size, we can then begin worrying about crowding out. For now, paying attention to Mr Mulligan is an utter waste of time.
