ECON 272

In Class Exercise Sixteen - The Criticisms of Government Deficit Spending

Answers are in Red

1.  What are Buchanan's two criticisms of government deficit spending?

1.  Deficit spending means future taxes and future interest payments.  Is it really moral to pass the bill on to the next generation?

2.  Once politicians can deficit spend, they will almost always want to do that - because it gets them votes.  Other means of paying down the debt will not get them as many votes as passing the bill on to the next generation.

2.  Explain why there are unseen costs to government deficit spending.  What might they be?

Because there are opportunity costs to the resources spent by the government.  If the money had not been loaned to the government - it could have been  utilized in different ways in the private sector.  They are "unseen" because we can never know where the money would have been used (invested, spent, etc.).  Might have been much more productive investment projects.

3.  Explain why a large government debt might harm economic growth (i.e., explain crowding out). Graph and words?

See your notes for the graph: 

Assuming that both savings and investment depend upon interest rates -

Then we have a loanable funds market (where saving is the supply of loanable funds and investment is the demand for loanable funds).  Investors borrow money in order to invest in their businesses.

When the government deficit spends (G-T), it enters this loanable funds market and the demand for loanable funds increases.  Due to this increase in demand (assuming savings is not increasing as well), the interest rate will be bid higher.

At higher interest rates - private investment will go down (more expensive to borrow) - this is the crowding out.  Money from savers is going to the government instead of to private investors.

This could lead to a drop in productivity because of the opportunity cost - money is moving from the productive private sector to the unproductive government sector.

4.  Can you explain a counter argument to crowding out?  And a counter to that?

Keynesian Counter:  If the money the government borrows is spend on infrastructure - it can also be productive spending.

Counter to the Counter:  The private sector could provide infrastructure and there is no guarantee that the borrowed money will be spent on infrastructure.

5.  What questions do you still have about this material?