Think of a standard IS-LM picture. Does that match current reality?
Obviously not: the Fed doesn’t target the money supply, so holding M
constant is not a useful thought experiment, and actually confuses
students. In fact, since the Fed actually targets the Fed funds rate
rather than the money supply, you might think that the LM curve should
be replaced with a horizontal FF curve. This would seem to suggest no
crowding out at all.
But except in the very short run the
Fed doesn’t set the interest rate passively; instead, it tries to
stabilize output around potential. A reasonable way to represent a
Taylor rule or something like that in a simple diagram is to draw a vertical line, the BB curve (for Ben Bernanke). This gives us 100% crowding out.
I think that’s right. Except in liquidity-trap conditions or in the
very short run, before the Fed has a chance to catch up, fiscal policy
doesn’t change aggregate demand, only the mix.
The source is Brad DeLong.