The purpose of this chapter is to examine the crowding-out phenomenon the process whereby an increase in government spending crowds out, or decreases, other components of aggregate demand, thus making the multiplier smaller. Some empirical estimates suggest that the multiplier may be as small as 0.6.
The multiplier process causes an increase in government spending, or any other exogenous increase in spending, to have a greater ultimate effect on the nominal level of income through price increases, real income increases, or both, depending on where the economy is relative to full employment. This phenomenon makes fiscal policy attractive for those who believe in government intervention to control the economy, but opponents of this Keynesian view claim that the magnitude of the multiplier, and thus the strength of fiscal policy, is greatly exaggerated. They accuse advocates of the Keynesian approach of not telling the whole story when explaining how the multiplier process operates. In particular, they claim the Keynesians have ignored the effects on the economy caused by the means used to finance an increase in government spending.
