Crowding-in

The term crowding-in , also known as the reinforcement effect, is a term used in economics and describes the increase in private-sector investments through state activities. The term denotes an important topic in Keynesian economic policy. The reinforcement effect is central to various economic models. The opposite effect in this context is called crowding-out (displacement effect ).

definition

Conceptual classification

The starting point of the crowding-in effect is a state economic policy that aims to prevent output gaps and stabilize the economic cycle . A demand-oriented economic policy , particularly monetary and fiscal policy , can help stabilize overall economic development. By influencing government spending and taxes in a targeted manner, the state has at its disposal fiscal policy, which can be traced back to the economic theory of John Maynard Keynes , an economic policy instrument to control aggregate demand. The restrictive (constructive) fiscal policy that is responsible for the crowding-in effect , which is concretized in a reduction in government spending and / or a tax increase, leads to a reduction in the interest rate and thus to an increase in investment demand (the lower the interest rate, the more attractive it becomes to take out a loan to make private investments). This increase in private investment by the state is known as the crowding-in effect .

Alternative definition

As a rule, the crowding-in effect relates to a longer period of time. Alternatively, crowding-in can also occur in the short term . In this case, the crowding-in effect is due to monetary policy, which forms the second pillar of economic policy alongside fiscal policy. In particular, the expansionary monetary policy , which is often used in a recessive situation, leads in the short term to an increase in the real money supply, an increase in production and a reduction in the interest rate, which leads to increased investments. Over time, however, the price level rises, so that the effects on production and interest rates subside. This adaptation effect continues until production is at its natural level . In the medium term , the interest rate assumes its original value and the nominal increase in the money supply is fully expressed in a proportional increase in the price level. The expansionary monetary policy therefore only leads to a crowding-in effect in the short term, in that the interest rate falls and investment demand increases, and in the medium term only to an increase in the price level.

application

As part of a restrictive fiscal policy , the state can reduce its budget deficit by increasing taxes or reducing government spending.

Adjustment effects in the AS-AD model

illustration 1

Figure 1 shows the dynamic adjustment effects of reducing the budget deficit in the AS-AD model . This reflects the overall economic equilibrium, consisting of aggregating supply (AS) and aggregating demand (AD) over the medium term. The point is the macroeconomic balance by the production on the natural level is and the actual price levels the price expectations correspond. As a result of the reduction in government spending from G to , production initially falls. The aggregated demand curve shifts to the left from to . In the short term, the equilibrium shifts from to , production goes back from to and the price level sinks from to . There is thus a close connection between production and price level, which can be explained as follows: ${\displaystyle A}$ ${\displaystyle Y_{n}}$ ${\displaystyle G'}$ ${\displaystyle AD}$ ${\displaystyle AD'}$ ${\displaystyle A}$ ${\displaystyle A'}$ ${\displaystyle Y_{n}}$ ${\displaystyle Y'}$ ${\displaystyle P}$ ${\displaystyle P'}$

• With the decrease in production, employment falls.
• With low employment, unemployment rises and with it the unemployment rate .
• The high unemployment rate worsens the bargaining position of workers, so that nominal wages fall.
• As a result of the decrease in nominal wages, production becomes cheaper and the individual companies lower their prices, which in turn causes the overall price level to drop.

Since production is now below its natural level and the actual price level is below the expected price level, the AS curve shifts from to . The economy eventually moves along the aggregated demand curve until it intersects the aggregated supply curve at the point . Over time, production therefore returns to its natural level at the point . However, not all variables assume their original value after the budget deficit has been reduced. Using the IS function : ${\displaystyle AS}$ ${\displaystyle AS''}$ ${\displaystyle AD'}$ ${\displaystyle AS''}$ ${\displaystyle A''}$ ${\displaystyle A''}$ ${\displaystyle Y_{n}}$

${\displaystyle {Y_{n}}=C({Y_{n}}-T)+I({Y_{n}},i)+G\!\,}$

• ${\displaystyle {Y_{n}}}$= natural level of production
• ${\displaystyle C}$ = Consumption
• ${\displaystyle T}$ = Taxes
• ${\displaystyle I}$ = Investment
• ${\displaystyle i}$ = Interest rate
• ${\displaystyle G}$ = Government expenditure

it becomes apparent that the composition of production must have changed, since the overall function remains unchanged in the medium term. Since taxes have not changed compared to the initial situation, consumption is also unchanged. Investments must have increased due to the reduction in government spending . For example, a reduction in government spending by 30 billion euros in the AS-AD model leads to an increase in investments of exactly 30 billion euros in the medium term. That is, the increase in investment corresponds exactly to the decrease in government spending. ${\displaystyle T}$ ${\displaystyle C}$ ${\displaystyle G}$ ${\displaystyle I}$

Adjustment Effects in the IS-LM Model

Figure 2

With the help of the IS-LM model , the increase in investments, which is based on the fall in the interest rate, can also be explained.
Figure 2 illustrates the effects of reducing the budget deficit as part of the IS-LM model. The intersection between the IS and LM curves represents the macroeconomic equilibrium in which the goods and money markets are in simultaneous equilibrium. Since the reduction in government spending initially reduces production, the IS curve shifts to the left, from to . An unchanged price level would move the economy from point to point . In the course of the decline in production, the lowering of nominal wages that is triggered decreases the price level, which results in an increase in the real money supply. The LM curve thus shifts from to and the economy initially moves from to . The interest rate is now lower than it was before the restrictive fiscal measure and production is below its natural level , which means that the price level continues to fall. In return, the real money supply continues to increase, so that the LM curve shifts further down until production has reached its natural level. The economy moves from point along the curve to point . At the intersection between the - and - curve (point ), production has returned to its natural level , but the interest rate has fallen from to . The medium-term reduction in the interest rate leads to an increase in investments. ${\displaystyle A}$ ${\displaystyle IS}$ ${\displaystyle IS'}$ ${\displaystyle A}$ ${\displaystyle B}$ ${\displaystyle LM}$ ${\displaystyle LM'}$ ${\displaystyle A}$ ${\displaystyle A'}$ ${\displaystyle Y'}$ ${\displaystyle Y_{n}}$ ${\displaystyle A'}$ ${\displaystyle IS'}$ ${\displaystyle A''}$ ${\displaystyle IS'}$ ${\displaystyle LM''}$ ${\displaystyle A''}$ ${\displaystyle Y_{n}}$ ${\displaystyle i}$ ${\displaystyle i''}$

Critical questioning of the crowding-in thesis

Use of fiscal policy

Figure 3

The purpose of fiscal policy is to compensate for economic fluctuations by means of the variation in taxes and government spending and thus to maintain stable growth. According to JM Keynes, the use of fiscal policy should be countercyclical ( Figure 3 ). Accordingly, the state should pursue an expansionary policy when the economy is in a recessionary phase. Conversely, a boom phase requires the use of a restrictive fiscal policy , in which the aim is to curb the economy or demand in order to avoid inflation .

However, the analysis of reducing the budget deficit using the IS-LM model has shown that as a result of government spending cuts or tax increases, interest rates fall and private investments increase as a result. The investment demand thus takes the place of the state demand, which only changes the structure, but not the volume of aggregate demand. At the same time, government agencies in the upswing tend to use rising government revenues relatively quickly for higher expenditure and not, as required, to shut them down. Especially since the state can often not easily reduce its expenditure during an economic upswing, as this is associated with layoffs of employees, postponement of construction measures, tax increases, etc. Combating signs of cyclical overheating through targeted restrictive measures is therefore proving difficult to implement.

Example - recession in Japan

The effects of reducing the government budget deficit explained above are model assumptions that represent a simplification of reality. A restrictive fiscal policy (also called deflationary policy), which is associated with a prolonged fall in the price level, is very rarely observed in practice. An example of this is the Japanese economy, which experienced severe deflation . Japan was once considered the engine of economic development and was able to record sustained production growth. The Japanese economy expanded enormously in the 1980s in particular. However, this upswing was followed by a recession in 1991/1992, which was slightly weakened in the mid-1990s, but ultimately culminated in the worst economic slump since the oil price crisis in 1997. The annual growth rate of production was on average from 1960–1991: 6.1%; 1992-2000: 1.3%; 2001–2003: 0.4%, so that Japan recorded a sharp decline in economic growth over time. As a result, unemployment increased and the inflation rate decreased. In Japan, the worsening of the crisis is mainly attributed to government budget policy. After a growth rate of over 2.7% in 1996 seemed to signal the end of stagnation , but at the same time budget deficits and national debt soared as a result of several stimulus injections, the government identified the budget deficit as a major problem in the Japanese economy. As a consequence, attempts were made to reduce the deficit by increasing taxes and restricting government spending. The restrictive fiscal policy thus choked off the recovery that had started earlier. The fall in employment resulting from the fall in government demand also resulted in a long-lasting fall in the price level. On top of that, companies were putting investments on hold, as Richard Koo noted.

literature

• Oliver Blanchard, Gerhard Illing: Macroeconomics . 4th edition, Munich 2006, ISBN 3-8273-7209-7
• Peter Bofinger: Fundamentals of Economics - An Introduction to the Science of Markets . Munich 2003, ISBN 3-8273-7076-0
• Josef Forster, Ulrich Klüh, Stephan Sauer: Exercises on Macroeconomics . 2nd edition, Munich 2006, ISBN 3-8273-7208-9
• Gerhard Mussel: Introduction to Macroeconomics . 8th edition, Munich 2004, ISBN 3-8006-3031-1

Web links

• Inflation rate japan
• International Politics and Society - Japan
• Country information from the Federal Foreign Office on Japan
• Compact economic data from the Federal Agency for Foreign Trade on Japan (PDF file; 2 kB)
• World Economic Outlook Database - Japan

Individual evidence

1. ↑ Cf. Mussel, Gerhard: Introduction to Macroeconomics, 2004, p. 183.
2. ↑ Cf. Mussel, Gerhard: Introduction to Macroeconomics, 2004, p. 190.
3. ↑ Cf. Blanchard, Oliver / Illing, Gerhard: Makroökonomie, 2006, p. 220.
4. ↑ Cf. Blanchard, Oliver / Illing, Gerhard: Makroökonomie, 2006, p. 224.
5. ↑ See Mussel, Gerhard: Introduction to Macroeconomics, 2004, p. 184.
6. ↑ See Encarta Encyclopedia, 2005, keyword: Japan - Economy.
7. ↑ Cf. Blanchard, Oliver / Illing, Gerhard: Makroökonomie, 2006, p. 34.
8. ↑ See World Economic Outlook Database - Japan (accessed: April 9, 2008, 7:06 pm CET).
9. ↑ See International Politics and Society - Japan (accessed: April 5, 2008, 14:32 CET).

This version was added to the list of articles worth reading on May 16, 2008 .