The effect of inflation uncertainty on ‘crowding out’

It is widely recognized that expansionary fiscal policy can crowd out private investment. The degree of crowding out depends in part on the degree of substitutability between public and private securities. In this paper, we look at how inflation uncertainty affects this substitutability and the degree of crowding out. Depending on the covariance of the return of private securities with the rate of inflation, the degree of substitutability, and thus the level of crowding out, will diminish as inflation uncertainty increases. Indeed, an increase in government debt may actually decrease the real return required on private securities, leading to “negative” crowding out.