Crowding out?

Peter Martin links to this argument from Shadow Treasurer, Joe Hockey, about the cause of the Commonwealth Bank’s (and maybe others) decision to raise home mortgage interest rates last week.

If the Government is borrowing so much money in competition with the banks, then the cost of funds to the banks will inevitably rise. You cannot continue with low interest rates whilst the Australian Government is borrowing billions of dollars every week to hand out cheques for $900.

The argument falls out of textbooks and is basically a re-statement of the Keynesian crowding out effect: that government borrowing comes from somewhere and if it is not overseas it will lead to a rise in domestic interest rates. Sinclair Davidson admonishes Martin for not reading first year texts. By the way, the rise in interest rates is the result of two effects. First, on the supply side for loanable funds, the government’s borrowing is in competition for private borrowing so rates rise. Second, the government deficit stimulates economic activity which, in turn, leads to higher interest rates. That, by the way, is the deficit working as intended and let’s face it our apparently up-swinging housing market is likely to be the cause of interest rate pressure there. The difference is that this second effect is not an increase in the cost of funding that the Commonwealth Bank and the Opposition are placing all of their weight on.

But in actuality, we need to think about what is causing the deficit. No one I guess has had a chance to do that like they have in the US but let’s pick on the stimulus cheques. Now the jury is out on what the impact of this has been. However, the Opposition have been definitive in their statements on this.

Following the release of the December national accounts in March, Malcolm Turnbull seized on a jump in the national savings rate to demonstrate that the Government’s cash hand-outs had been ineffective. “It is now beyond any doubt that over 80 per cent of that money was saved and not spent. In other words, it produced very little bang for the buck,” the Opposition Leader said at the time.

Hang on a minute. Let’s get the argument clear now. The stimulus cheques are (a) pushing up bank loan funding for lack of funds and, at the same time, (b) are being saved rather than spent. Where exactly is this money being saved? I am willing to bet that it is either with banks as deposits or to pay off debt held by the banks. So the money is going out one door and, in large part, straight back in the next. This suggests that the supply-side isn’t really the cause of higher interest rates but instead if there is a cause it is the demand side and the fact there is insufficient competition in banking to keep interest rates related to cost. But I guess people can be excused for missing all of that. It is really Econ 201.

9 thoughts on “Crowding out?”

  1. any sane person would surely come to the conclusion that it is due to the lack of competition. Something the Government needs to live with in the present circumstances. How anyone with a straight face could say this is an example of crowing out given the lack of actual spending by the Government thus far and the lack of demand for funds by the corporate sector is beyond me.

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  2. Just to clarify, does this mean that you agree with Sinclair Davidson that most of the hand-outs have been saved and consequently have been relatively impotent with regards to stimulating consumer spending?

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  3. On the issue of whether handouts have been saved or not, that is a matter for the data and there has been no thorough study of that and likely will not be for years until it is released.
    My point is that you cannot simultaneously believe that the handouts were saved and there is crowding out of the form the Opposition and Sinclair Davidson are suggesting.

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  4. “My point is that you cannot simultaneously believe that the handouts were saved and there is crowding out of the form the Opposition and Sinclair Davidson are suggesting.”

    That position is not really contradictory as there’s a time delay between the borrowing of the funds and the replacement of supply so some crowding out is inevitable even if the vast majority of the funds end up back in savings (minus a heap of bureaucratic waste.)

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  5. I would have thought the most logical conclusion is that some of the handouts would be spent and some saved, and that the crowding out effect is applicable to the part that is spent.
    The only reason both are not possible is if Ricardian equivalence is 0% or 100%. It is much more likely to fall somewhere in the middle.

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  6. Joshua you surprise even more than you have in the past. Are you actually serious in saying this as somehow being relevant to the subject of bank competition?
    This suggests that the supply-side isn’t really the cause of higher interest rates but instead if there is a cause it is the demand side and the fact there is insufficient competition in banking to keep interest rates related to cost.
    Ummm. CBA had the lowest rate!
     
    I really don’t think you understand competition.


     

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  7. Interesting that you can’t even describe your competition problem, Joshua. I’m think you’re having one of those Fuelwatch moments again.
     
    Esra:
     
    Unless I’m mistaken and I admit it could change at any moment we live in a capitalist system where firms are actually allowed to charge what the market will bear (fancy that). If you have an issue with the margin then i suggest you take your concerns to the central bank as that is the entity which guides rates up or down.
     
     
     

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