How does that help us understand the counterintuitive examples of the large Japanese debt, the Brazilian spending-fueled recession, or Greek austerity?
Credibility is the main driver of the reaction in our model of public/private investments.
Here is the technical part: the fiscal multiplier depends on the response of the supply curve of loanable funds to government borrowing, and its evolution over time.
We summarize sophisticated dynamics into our simple model of step 1: government, step 2: companies and households. Interest rates would not increase, and whatever deficit the government incurs would have no impact on the real interest rate of the economy. Lack of trust can cause the public to always react in the opposite direction; people would be trying to protect themselves from an incompetent government.
If people are willing to supply funds to this government, the fiscal multiplier works, and the third-world Keynesianism taught in Brazilian schools is born. Even if that is true for some countries (hello, Venezuela and Zimbabwe!
And here is something where the original Keynes was right but that it seems to have been forgotten by many contemporary Keynesians: expectations and credibility matter. Whenever the credibility of governments is high and expectations align with the decision of public authorities, the supply of loanable funds increases and there is crowding in.
Government spending is more easily financed, companies invest more, the interest rate does not increase much, and society benefits. Let’s apply what we have learned so far to the counterintuive results in the world economy; we can even use it to make some predictions.
A simple representation of this on the loanable funds market (Investment is ALL aggregate investment, public and private; ditto for Saving (S)): The government wants to borrow more (step 1). ), there is no way that perfect crowding out is pervasive around the world. There are two moderating effects on the link between fiscal spending and economic growth over time: the public debt trajectory and the efficiency of public spending.
This is the intuition: governments can be bad when they are incompetent, or good if public authorities are remotely competent (and consistently so). Let’s use the example of Egypt, where the government decided to to build a new capital and is financing most of the USD 45 billion necessary to erect it .
I will try my best to keep it as simple as possible, but be advised that the infamous supply and demand curves do show up at some point. By Keynesianism I mean a view of economics that use some of what John Maynard Keynes proposed in his magnus opus “The General Theory of Employment, Interest and Money” but is also informed by some other economists, like Michał Kalecki.
Here is the thing that most textbooks miss: economics is context-dependent. Austerity may destroy social welfare in Germany but enhance it in Greece. Austerity may be the correct path one year and not the next. My training as an economist came from professors who were unabashed Keynesians.
Nevertheless, that does not mean that government expenditures create true prosperity.