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Government spending and interest rates

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  • Murphy, Daniel
  • Walsh, Kieran James

Abstract

Most macroeconomic models imply that increases in government spending cause interest rates to rise, but empirical evidence from the U.S. generally fails to support this prediction. We propose a novel explanation for how government spending can have a zero or negative temporary effect on interest rates: the increased demand for credit associated with government spending is offset by an increase in the supply of credit due to higher aggregate income. We demonstrate this mechanism theoretically and provide evidence consistent with the model’s predictions.

Suggested Citation

  • Murphy, Daniel & Walsh, Kieran James, 2022. "Government spending and interest rates," Journal of International Money and Finance, Elsevier, vol. 123(C).
    • Handle: RePEc:eee:jimfin:v:123:y:2022:i:c:s0261560622000018
    DOI: 10.1016/j.jimonfin.2022.102598
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    References listed on IDEAS

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    Cited by:

    1. Miranda-Pinto, Jorge & Murphy, Daniel & Walsh, Kieran James & Young, Eric R., 2023. "Saving constraints, inequality, and the credit market response to fiscal stimulus," European Economic Review, Elsevier, vol. 151(C).
    2. Andrea Cipollini & Francesco Frangiamore, 2023. "Government spending and credit market: Evidence from Italian (NUTS 3) provinces," Papers in Regional Science, Wiley Blackwell, vol. 102(1), pages 3-30, February.

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    More about this item

    Keywords

    Interest Rates; Fiscal Policy; Aggregate Demand;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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