Question

Under what condition would crowding out not inhibit long-run economic growth? Under what condition would crowding out impede long-run economic growth?

Short answer

Crowding out would not inhibit long-run economic growth under conditions such as flexible interest rates, idle resources, counter-cyclical government spending, and productive government spending. On the other hand, crowding out would impede long-run economic growth under conditions like rigid interest rates, limited or no idle resources, pro-cyclical government spending, and unproductive government spending.

Step-by-step solution

Conditions for crowding out not inhibiting long-run economic growth

Crowding out would not inhibit long-run economic growth under the following conditions: 1. **Flexible interest rates:** If interest rates are allowed to adjust freely in response to changes in government spending, private investment may not be crowded out due to increased government spending. As government spending increases, interest rates may rise, attracting more savings and private investment. 2. **Idle resources:** If an economy has idle resources (unemployed workers or unused capital), increased government spending can put those resources to use without displacing private investment, thus not crowding out the private investment. 3. **Counter-cyclical government spending:** In cases where the government spends during economic downturns and reduces spending during economic expansions, crowding out may not inhibit long-run economic growth. This is because during economic downturns, private investment may be low due to decreased consumer spending, and government spending can help stimulate the economy. 4. **Productive government spending:** If the increased government spending is directed towards productive investments (e.g. infrastructure, education, and research and development), it might lead to long-run economic growth even if some crowding out of private investment occurs.

Conditions for crowding out impeding long-run economic growth

Crowding out would impede long-run economic growth under the following conditions: 1. **Rigid interest rates:** If interest rates are fixed or cannot fully adjust in response to changes in government spending, increased government spending can lead to a decline in private investment. This is because the higher demand for funds from the government can lead to a shortage of funds available for private investors, which can reduce private investment and long-run economic growth. 2. **Limited or no idle resources:** In an economy with limited or no idle resources, increased government spending will likely result in the displacement of private investment, as resources are fully employed. 3. **Pro-cyclical government spending:** If the government increases spending during periods of economic expansion and reduces spending during downturns, crowding out is more likely to occur, inhibiting long-run economic growth. This is because during economic expansions, private investment is already high, and increased government spending can lead to higher interest rates, lower private investment, and reduced long-run growth potential. 4. **Unproductive government spending:** If the increased government spending is directed towards unproductive investments (e.g., wasteful projects or spending on consumption), it might lead to crowding out and reduced long-run economic growth. In such cases, private investment could have been more productive as compared to government spending, thus impeding long-run growth potential.