May 9, 2013
The Heritage Foundation’s Salim Furth writes:
If interest rates are responsive to news, most macroeconomic models agree that government “stimulus” spending crowds out private investment. In usual times, with responsive interest rates, New Keynesian models typically have a strong role for monetary (Fed) policy but little or no role for fiscal policy (stimulus spending or tax rebates). In Neoclassical as well as New Keynesian models, government stimulus spending diminishes private activity—especially investment—as private borrowers are crowded out of the market by government borrowing. In contrast, New Keynesian models suggest that when the interest rates relevant for investing are constrained by the zero lower bound, the crowding-out mechanism stops functioning and fiscal policy can be expansionary.