Costs of the New Government Activism

This is a post by John Taylor at his Economics One. He discusses a paper by Alan Greenspan. Excerpts:

"...government-induced uncertainty causes businesses to increase their liquid investments (bank deposits, government bonds, etc.) at the expense of illiquid investments (business fixed investment in structures and equipment)."

"Nevertheless, he finds a large and significant negative effect of this variable: a one percentage point increase in the deficit as a share of GDP, due say to Keynesian stimulus programs, reduces the ratio of business fixed investment to internal funds by 3.3 percent after controlling for capacity in the nonfinancial corporate sector."

"The rest of the decline in investment he attributes to other aspects of the activism, concluding that “a minimum of half the post-crisis shortfall in capital investment, and possibly as much as three quarters, can be explained by the shock of vastly greater government-created uncertainties embedded in the competitive, regulatory and financial environments”"

"...reducing the cyclically-adjusted deficit through reduced spending will crowd in private investment as firms allocate a larger fraction of their cash flow to new investment. The estimated effect on investment is virtually immediate occurring within one quarter."