Greg Mankiw discusses the fiscal policy multiplier in a closed economy setting that ignores Mundell’s net export crowding-out effect. Brad DeLong and Mark Thoma beg to differ on the extent of crowd-out by noting that the Federal Reserve neither targets interest rate nor the money supply. Mark provides some nice graphs with the point being:
Krugman is saying this is not how the Fed operates in the short-run. Instead, the Fed moves to stabilize output at Y* so that the LM curve shifts back, not out, and output remains at Y*. In this case, crowding out is 100%
William Poole would be impressed that folks remember his 1970 point in Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model . Of course – once realizes the point that Poole was making – the case of Bush’s tax cuts as somehow being pro-growth disappears. Simply put – less national savings means less investment.