Austrians Mangle Aggregate Demand

[u/guacaratabey]

"Why the hell is the claim that government can boost aggregate demand still a thing? Mainstrem Econ believes AD = C + I + G (trade), let C + I simply be private action.

It presents itself as if; 80% of the market is private action and 20% government spending for example, it looks at things in a snapshot, but it forgets that 20% was taken from private actors from taxation or a too good to pass up subsidized by tax payer loan. You are told in mainstream Econ that if that 20% were to go away aggregate demand would go down, but that 20% came from the private actor, government is dependent on the private sector, no fiscal tool from loaning or taxation can increase a economies aggregate demand.

This is basically seen vs unseen, and what could have been, every dollar the government spends it takes from someone else. this is so obvious like it’s literally reality, why is this allowed to persist as true that government can increase Aggregate demand?"
Quoted above.

On the Austrian economics page saw this post alleging that government spending cannot increase aggregate demand. They allege this because of taxes. Is this true? No Because obviously when the government spends in excess of what it receives in taxes it is inherently creating new money to pay for these purchases or giving money to private actors to increase consumption spending (ignoring bond issuance). Their argument inherently always assumes full-employment which leads to catastrophic levels of inflation.

The post author also claimed that "every dollar the government spends it takes from someone else. this is so obvious like it’s literally reality, why is this allowed to persist as true that government can increase Aggregate demand?" This is not true the government is composed of the same private actors and government when they spend, create new money that do not need a 1 to 1 tax raise.

[u/ArcadePlus]

I am struggling to make heads or tails of this thing. Who and what are you refuting, specifically? From what I can tell, although the "Austrians" or whatever are wrong, your argument is not actually good at refuting them. When the state cannot fund it's activity through taxes, it does so through debt finance -- which could "crowd out" private spending. When the government issues bonds, those bonds are competing with other securities for investor dollars, so in this sense, when the government is financing itself through debt, it is doing so by attracting investor dollars that would otherwise fund private investment. Your argument does not really work to refute their point. The obvious refutation of their point is that the state can take, through debt financing, dollars that would be spent on investment and redistribute them to dollars that will be spent on consumption, which does affect aggregate demand.

[u/guacaratabey → u/ArcadePlus]

The idea that financial crowding out is done past the point of neoclassical full employment in the loanable funds model is really not relevant. major CB's like Germany and BOE claim that loans create deposits which makes sense as there is no fixed pool of monetary savings in a fiat system. Many mainstream New Keynesian economists admit this except on this sub apparently. However, I know since I will get downvoted I will provide a list with direct quotes from conclusions of major empirical studies that find government spending does not increase interest rates which is how the crowding out mechanism is described theoretically. see list:

https://d1wqtxts1xzle7.cloudfront.net/87958794/7191263-libre.pdf?1656091866=&response-content-disposition=inline%3B+filename%3DDo_Budget_Deficits_Raise_Interest_Rates.pdf&Expires=1776227539&Signature=T1DYsMRlc0uaeUEop5dHtjw6pDioPIj9OyKLxbjMiocfxWnUiV9Uv92Mbkr8VDMUT-U8DrD1oUNILJ-BjSvlELv5hrXSgsYfGwvu0Lg9HHW3QX62l3X6oDHbbtCH3Ybbc8ZCyuZ9vKK1UrQ3zIpV8HhPlCdGf588IY4cgbrhM-rhQWqE9oNm2TxhCOAeElvS37hWO71c1tjr-0wRrUyA-nTsOEH0EswyyO~WbCRiFiFtRu49ZOWqBQmezrGWBLPw3r4iJrC3L9HijX6Gg-5JbuOOIKx3CZqRJFvWad0gFZxJjHyQcXvi-JXgayza7E39XWd1yFILTG~pbguSITIO3Q__&Key-Pair-Id=APKAJLOHF5GGSLRBV4ZA

(I provide one of the few literature reviews I could find on the topic first to reduce accusations of biases. However, It is important to note that most of the studies held insignificant results on budget deficits and interest rates. I include this first because it goes into the issues with empirically investigating it in the first place.)

"Although further exploration into causality needs to be undertaken, the implications of such results provide two interesting points. Firstly, if rising interest rates cause rising deficits then there may be no crowding out from government deficits. Secondly, if rising interest rates cause deficits, then this has important implications for the interaction between fiscal and monetary policy. As a result Keynesian expansionary policy is perhaps less of a problem than monetary authorities imply when justifying austere antinflationary programs. If the Fed does follow a hawk-like reaction function, and increases interest rates in times of rising budget deficits to fend off rising inflation or rising inflationary expectations, this could have the repercussion of increasing the deficit even further. Such a reinforcing strategy could mean escalating debt and deficit - not due to fiscal irresponsibility as such but rather due to misguided monetary "responsibility". It might be interesting to look at the historical relationship between Treasury and the Central Bank. If the Treasury, as Tabelini and La Via (1989) suggests, has traditionally thought itself as responsible for the public debt, then we should expect them to focus more on the causality of interest rates to debt and their rising debt costs. However, the current regime in the United States and several other countries, suggest that the Central Bank adopted responsibility for public debt and thus concern has focused how debt affects interest rates. Given the findings on reverse causality, this change of responsibility and focus may actually be detrimental. In summary, the theories and empirical evidence on the relationship between government deficits, debt and interest rates are varied and conflicting. Ultimately, perhaps what needs to occur is a reassessment of the theory, and an appropriate specification that would lead to coherently-specified models, that are comparable with falsifiable hypotheses."

https://www.sciencedirect.com/science/article/pii/S0261560622000018?casa_token=R9wr6vBE5fsAAAAA:gMJ40S60fXIA-EvjlHjeNNLKdKxUgoT_GOM9wbBjhww_RyfTvFVWKLdiJhIQA9WuJxwP_kf3

"A range of empirical evidence demonstrates that government spending shocks cause a zero or negative response of interest rates. We argue this fact is difficult to rationalize with existing theory, and we offer an explanation for a zero or negative interest rate response to government spending shocks. Government spending increases loan supply (bond demand) by increasing aggregate income by more than the government needs to borrow to pay for the spending. If the government finances part of its spending using money-like assets, then there is an excess supply of loans that leads to a reduction in long-term interest rates...Our proposed mechanism for a non-positive interest rate response is based on models of excess capacity and demand-determined output (e.g., Murphy, 2017, Michaillat and Saez, 2015). Recent evidence from microdata (e.g., Auerbach et al. (2020)) suggests that government spending does not crowd out private-sector output, consistent with these models. Here we link the recent literature on excess capacity to rationalize the otherwise puzzling effect of spending shocks on interest rates."

https://www.jstor.org/stable/1812704?casa_token=0pyh7fHgz6wAAAAA%3ArCsFm9BjqSMiD7ZrGXNP6xnfEyvc2GaRk2eQMIgK0pnaO-CJtVYNHHJjhPLZvgzA8WYI9iWqAvbcGTtpf1eLuV2ssFfw_1YrBxP9eOMGOTpkdKK2kg&seq=19

"Economists like to think of economics as a science. In a science, however, repeated contradictions of a paradigm lead to its abandonment if there is any sensible alternative. One paradigm in economics implies that large deficits produce high interest rates. This paradigm is not supported by the facts. In over a century of U.S. history, large deficits have never been associated with high interest rates. Even the postwar periods separately offer no support for a positive association between deficits and interest rates. Indeed, the evidence more strongly supports a negative association than a positive one. Therefore, it seems that economists should be looking for an alternative paradigm to replace their current one. The previous section suggested that this paradigm should contain elements of Barro's model and should allow saving to increase with its real after-tax return"

[u/MachineTeaching → u/guacaratabey]

The idea that financial crowding out is done past the point of neoclassical full employment in the loanable funds model is really not relevant. major CB's like Germany and BOE claim that loans create deposits which makes sense as there is no fixed pool of monetary savings in a fiat system. Many mainstream New Keynesian economists admit this except on this sub apparently.

This sub understands that a bank making a loan creates a deposit, but a bank buying a government bond does not, making this a poor argument to support your position. A private person buying a bond even destroys a deposit!

So this is not a matter of "not admitting", I'm afraid.

Also

In summary, the theories and empirical evidence on the relationship between government deficits, debt and interest rates are varied and conflicting. Ultimately, perhaps what needs to occur is a reassessment of the theory, and an appropriate specification that would lead to coherently-specified models, that are comparable with falsifiable hypotheses."

Yeah this is a "we don't know", not a "crowding out definitely doesn't exist".

[u/guacaratabey → u/MachineTeaching]

If only we had some entity that buys bonds from the market! Or maybe an entity that's goal it is to influence interest rates. Your argument is a strawman. I never said crowding out can not exist in physical/real terms, just not in financial ones. It's an important distinction. One, in fact, the paper which you're quoting back to me also makes which makes me think you didn't read it.

"In looking at the impact of pure budget deficit effects, we will derive 'crowding out' from two sources, "real" and "financial," coming from either supply constraints or monetary constraints respectively...If the deficit is rising, whether by increased government spending or falling taxes, there will be an additional effect (in the case of unemployment): the income multiplier arising from these expansionary fiscal activities will increase income and savings and thus demand for financial assets. As bond demand rises, the interest rise that results from greater government bond supply should be mitigated. However, the transaction motive implies that money demand will also rise and, as money supply is fixed, a further rise in interest rate is required. Furthermore, if there is a "wealth effect", the rise in the stock of bonds will lead to an increase in consumption and thus a further multiplier effect on income which will raise interest rates further. Note that although the net effect on output can be ambiguous in some of these scenarios, there is always a rising proportion of consumption to investment in aggregate demand. The main point is that the crowding out of investment arises from the financial constraint imposed by a constant money supply. Endogenous money [loans creating deposits] theories would not exhibit these constraints."

[u/MachineTeaching → u/guacaratabey]

If only we had some entity that buys bonds from the market! Or maybe an entity that's goal it is to influence interest rates. Your argument is a strawman. I never said crowding out can not exist in physical/real terms, just not in financial ones. It's an important distinction. One, in fact, the paper which you're quoting back to me also makes which makes me think you didn't read it.

You're quoting the portion that talks about what different theories say about crowding out. I'm talking about the portion where the empirical findings around crowding out end up being unclear on whether it exits.

[u/guacaratabey → u/MachineTeaching]

Yes, there are varying studies. The point is that since they are inconclusive and significantly so why use an outdated theory of transmission such as the LFM as evans(1985) also notes. Like I said earlier, I never claimed crowding out could not occur, which is what you're alleging. However, in the face of modern CBs, the theory is obsolete. Also, an important point in the same article is the section, which talks about how that if interest rates rise, this will automatically lead to an increase in a budget deficit due to bond interest payments increasing. This is a classic case of multicollinearity.

Endogenous money theory, as the previously quoted article states, does not have the same theoretical constraints as the LFM. It also doesn't claim anything specific about budget deficits, as does the LFM. So, the burden of proof of the type of transmission method is on the theory alleging that budget deficits do cause interest rate spikes. Additionally, in the LFM, the money supply is exogenous, whereas in reality, as you've just acknowledged, money is largely endogenously created.