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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)

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/RePEc/eej/Archive/Volume15/V15N3P203_212.pdf
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Bibliographic Info

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. 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.
  2. 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.
  3. 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.
  4. Cebula, Richard & Carlos, Christopher & Koch, James, 1980. "The "Crowding Out" Effect of Federal Government Outlay Decisions: An Empirical Note," MPRA Paper 51554, University Library of Munich, Germany.
  5. 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.
  6. 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.
  7. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
  8. 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.
  9. Dalamagas, Basil A, 1987. "Government Deficits, Crowding Out, and Inflation: Some International Evidence," Public Finance = Finances publiques, , vol. 42(1), pages 65-84.
  10. Hendry, David F & Mizon, Grayham E, 1978. "Serial Correlation as a Convenient Simplification, not a Nuisance: A Comment on a Study of the Demand for Money by the Bank of England," Economic Journal, Royal Economic Society, vol. 88(351), pages 549-63, September.
  11. Bernanke, Ben S, 1981. "Bankruptcy, Liquidity, and Recession," American Economic Review, American Economic Association, vol. 71(2), pages 155-59, May.
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Cited by:
  1. Maria Carme Riera i Prunera, 2003. "Deficit, human capital and economic growth dynamics," Working Papers in Economics 102, Universitat de Barcelona. Espai de Recerca en Economia.

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