One of the more interesting aspects of Federal Reserve Chairman Ben Bernanke's lecture today (Thursday) at George Washington University was the affirmation of the crowding-out thesis.
The crowding-out argument states that bailouts and stimulus plans don't work when backed by deficit spending.
"The added debt absorbs savings that would otherwise go to private investment. In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another," economist Eugene Fama has argued.
It's a controversial idea. Fama's use of it provoked Paul Krugman to announce that we had entered the "Dark Age of Economics."
But the way Ben Bernanke describes the economics of quantitative easing, it seems that he endorses Fama's view.
Bernanke argued in his lecture that when the Fed bought GSE and Treasury securities as part of the quantitative easing program, it created a vacuum in the market for bonds. Investors seeking bonds faced a shortage of government-backed securities and turned instead to corporate bonds, lowering their yields in turn.
The corollary of this is that absent monetary accommodation, fiscal policy is indeed ineffective. If the Fed doesn't act to create the vacuum, the additional issuance of government bonds will crowd out private investment and drive up yields on corporate bonds.
I wonder if Krugman will call Bernanke an apostle of the dark age?
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