Default Risk and the Effects of Fiscal Policy on Interest Rates: 1929–1945

David Bowles, Holley Ulbrich and Myles Wallace
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David Bowles: Southern Bell

Public Finance Review, 1988, vol. 16, issue 3, 357-373

Abstract: Conventional macroeconomic models suggest that expansionary fiscal policy causes higher interest rates, resulting in crowding out of private investment. In this article, we argue that such models ignore the default risk differential between the interest rates on government bonds and corporate bonds. If expansionary fiscal policy causes an expansion in real GNP, default risk falls on corporate bonds. Our model suggests that if the default risk premium falls, (1) corporate interest rates may fall relative to rates on government bonds and (2) private investment is crowded in. We find some supporting empirical evidence of this effect for the period 1929–1945.

Date: 1988
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Persistent link: https://EconPapers.repec.org/RePEc:sae:pubfin:v:16:y:1988:i:3:p:357-373

DOI: 10.1177/109114218801600307

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