Just want to see if I have the concept straight. When the gov’t is running a deficit, there is less in the way of available funds for borrowing out in the economy. Because the supply is low, interest rates rise to establish a new equilibrium with demand. The problem is, these higher rates may be prohibitive for many private investors. They will decided not to borrow and invest in various capital projects. As a result, the growth rate of potential GDP is reduced and the Lucas Wedge gets bigger. Now, the whole concept assumes that the impact of the reduced borrowing and investment by the private sector is material against the increased government expenditures that lead to the original deficit. The last step is the Ricardo-Barro effect. Because the government will eventually need to raise funds to cover the existing deficit, individuals assume that taxes in future periods will be higher. In order to plan for the decrease in future wealth, they save more today. As a result, there are more funds available for borrowing – interest rates should fall making borrowing less expensive – and private side investment should increase a little. ------ Am I correct… off in left field. With test scores in the upper 70’s overall and scores in econ in the 40’s, I’m trying to gain some much needed ground here!! 
What is the Lucas wedge effect mate? I have n’t read the SS but as far as I think barro effect suggest that there is no crowding out as people save more to pay for the tax later.
mcf Wrote: ------------------------------------------------------- > Just want to see if I have the concept straight. > > When the gov’t is running a deficit, there is less > in the way of available funds for borrowing out in > the economy. Because the supply is low, interest > rates rise to establish a new equilibrium with > demand. The problem is, these higher rates may be > prohibitive for many private investors. They will > decided not to borrow and invest in various > capital projects. As a result, the growth rate of > potential GDP is reduced and the Lucas Wedge gets > bigger. > > It sounds right. Govt’s exp > tax revenue situation generates small expenditure by individuals (crowding out)
Lucas wedge is, as the name would imply, is a graphical item. But the concept is that by doing anything that restricts GDP growth… like running a deficit that causes the crowding out effect… you limit the possibility for future growth. It’s sort of an exponential growth theory I believe.