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


  • David Bowles


  • Holley Ulbrich

    (Clemson University)

  • Myles Wallace

    (Clemson University)


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.

Suggested Citation

  • David Bowles & Holley Ulbrich & Myles Wallace, 1989. "Default Risk, Interest Differentials and Fiscal Policy: A New Look at Crowding Out," Eastern Economic Journal, Eastern Economic Association, vol. 15(3), pages 203-212, Jul-Sep.
  • Handle: RePEc:eej:eeconj:v:15:y:1989:i:3:p:203-212

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    References listed on IDEAS

    1. Dalamagas, Basil A, 1987. "Government Deficits, Crowding Out, and Inflation: Some International Evidence," Public Finance = Finances publiques, , vol. 42(1), pages 65-84.
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    Cited by:

    1. Wisniewski, Tomasz Piotr & Lambe, Brendan John, 2015. "Does economic policy uncertainty drive CDS spreads?," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 447-458.
    2. 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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