Government spending "crowds out" private spending. At best, it transfers a dollar of private spending through taxation to the public sector. However, closer analysis of government spending confirms that it is less efficient in creating income and wealth than private spending. For example, no rational consumer buying a new car would destroy his old car worth $3,000 unless he was given $4,000 of someone else’s money in a “cash for clunkers” program to do so.
The liberal establishment maintains that it is not current taxation that finances the government deficit-spending, but debt. Thus it is not crowding out private spending. However, government debt crowds out private borrowing and investment. Liberal economists argue that government borrowing is not crowding out private investment because the banks have plenty of money to lend to the private sector. Unfortunately, in an attempt to protect depositors and the government guarantee of such deposits, the bank regulators have increased the credit underwriting standards on the banks. Consequently, banks are not lending to struggling small and medium-sized businesses that need working capital to grow and create jobs.
Monetary stimulus is no longer an option. Over the past three years, the Federal Reserve has attempted to stimulate the economy by printing money and reducing short-term interest rates to near 0 percent. Unfortunately, this monetary stimulus is setting the stage for inflation.