Title: Do budget deficits crowd in or crowd out private investment: evidence from Europe

Authors: Mohsen Bahmani-Oskooee, Charikleia Economidou

Addresses: The Center for Research on International Economics and Department of Economics, The University of Wisconsin-Milwaukee, Milwaukee, WI 53201, USA. ' The Center for Research on International Economics and Department of Economics, The University of Wisconsin-Milwaukee, Milwaukee, WI 53201, USA

Abstract: The impact of budget deficits on private investment is an unsettled issue. If budget deficits are to be financed by borrowing, interest rates must rise so that capital markets can reach equilibrium. High interest rates, in turn, result in a decreased investment, hence the crowding-out effect. On the other hand, if budget deficits help boost economic growth, investors could become more optimistic and decide to invest more, hence the crowding-in effect. Finally, if an increase in deficits due to tax cuts today is to be matched by tax increases in the future, interest rates and investment may not change. In this paper we employ cointegration analysis and data from nine European countries to test the impact of budget deficits on private investment.

Keywords: budget deficits; crowding-in; crowding-out; private investment; European Union; fiscal policy; government budgets.

DOI: 10.1504/IJPP.2006.009799

International Journal of Public Policy, 2006 Vol.1 No.3, pp.223 - 232

Published online: 14 May 2006 *

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