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Default Risk, Interest Differentials and Fiscal Policy: A New Look at Crowding Out

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Author Info
David Bowles (BellSouth)
Holley Ulbrich (Clemson University)
Myles Wallace (Clemson University)

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Abstract

The crowding out debate fails to incorporate the impact of expansionary policy on interest rates for private sector borrowing through changes in perceived default risk. In a modified IS-LM model with default risk dependent on the state of the economy, government borrowing has an indeterminate effect on interest rates for private borrowers; reduced default risk mitigates any crowding out effect. Testing the model with data from 1959-85 verifies a default risk effect for both monetary and fiscal policy. Expansionary policy reduces the spread between Baa corporate bonds and Treasury bonds of equal maturity.

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File URL: http://college.holycross.edu/eej/Volume15/V15N3P203_212.pdf
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Article provided by Eastern Economic Association in its journal Eastern Economic Journal.

Volume (Year): 15 (1989)
Issue (Month): 3 (Jul-Sep)
Pages: 203-212
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Handle: RePEc:eej:eeconj:v:15:y:1989:i:3:p:203-212

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  1. Blinder, Alan S & Stiglitz, Joseph E, 1983. "Money, Credit Constraints, and Economic Activity," American Economic Review, American Economic Association, vol. 73(2), pages 297-302, May. [Downloadable!] (restricted)
    Other versions:
  2. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
  3. Bernanke, Ben S, 1981. "Bankruptcy, Liquidity, and Recession," American Economic Review, American Economic Association, vol. 71(2), pages 155-59, May.
  4. Benson, Earl D & Rogowski, Robert J, 1978. "The Cyclical Behavior of Risk Spreads on New Municipal Issues," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(3), pages 348-62, August. [Downloadable!] (restricted)
  5. Leonall C. Andersen & Jerry L. Jordon, 1968. "Monetary and fiscal actions: a test of their relative importance in economic stabilization," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 11-23. [Downloadable!]
  6. Jaffee, Dwight M., 1975. "Cyclical variations in the risk structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 1(3), pages 309-325, July. [Downloadable!] (restricted)
  7. Davidson, James E H, et al, 1978. "Econometric Modelling of the Aggregate Time-Series Relationship between Consumers' Expenditure and Income in the United Kingdom," Economic Journal, Royal Economic Society, vol. 88(352), pages 661-92, December. [Downloadable!] (restricted)
  8. Cook, Timothy Q & Hendershott, Patric H, 1978. "The Impact of Taxes, Risk and Relative Security Supplies on Interest Rate Differentials," Journal of Finance, American Finance Association, vol. 33(4), pages 1173-86, September. [Downloadable!] (restricted)
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