Readers Question: we say that higher fiscal spending leads to higher economic growth but does this negative public saving also not lower investments hence lowering future growth opportunity? so is the current growth stimulus at a cost of future growth?
- Cutting taxes and boosting spending will lead to higher borrowing. This will hopefully boost aggregate demand and lead to higher growth.
- Some people argue this will cause crowding out.
- Increased government borrowing means the government borrow from private sector. (e.g. private sector buy government bonds). Therefore the private sector has less money for private sector investment. Therefore, in the long run, there is no actual increase in aggregate demand. (furthermore, private sector investment may be more efficient than public sector investment)
- Higher government borrowing could also lead to higher interest rates because the rise in borrowing causes bond yields to rise in order to attract savers.
However, this ‘crowding out’ doesn’t have to occur in a recession. This is because it is argued that the private sector have no inclination to invest. In a recession people want to save, therefore the government is investing money which otherwise would have remained inactive.
- There may also be a multiplier effect of government investment. The initial investment may cause the economy to recover and the private sector to start employing more people, therefore it won’t just be the government investment that increases economic growth.
- If the economy recovers more quickly then government tax receipts will increase sooner. Also with lower unemployment spending falls.
- If the government does nothing and allows the recession to persist; then there can be a permanent fall in productive capacity as factories permanently close down. (this occurred in the Great Depression in the 1930s – certainly, policies to balance the budge in the 1930s were a mistake)
- As the economy recovers, the government can start to repay the debt without crowding out private sector investment because they now have the confidence to invest.
- Generally speaking, I do think it makes sense to borrow in a recession. This will make a recession shorter and it need not lead to lower growth in the future.
Related
- UK National Debt – with details of servicing UK debt interest payments (currently £48bn a year)