New evidence on financial crowding out

Abstract

This paper has provided evidence that federal government borrowing has in fact, as least for the period 1970 through 1982, exercised a significant impact upon short term interest rates in the private sector. In particular, it is shown here that the rate of change of the interest yield on three-month T-bills exercises a positive and very highly significant impact upon the rate of change of the prime rate of interest. To the extent that private sector spending is sensitive to the interest rate, a very strong argument on behalf of financial crowding out can be made. The results provided here differ dramatically from those in the related studies by Dwyer (1982) and Hoelscher (1983). For example, Hoelscher (1983: 332) finds ‘... no significant relationship between Federal borrowing and short term interest rates for the post World War II period.’ The results in Dwyer (1982) and Hoelscher (1983) differ from those presented here for a number of reasons, including: (1) the fact that the present paper deals only with the period 1970–1982, whereas Dwyer (1982) and Hoelscher (1983) deal with the entire post World War II period; and (2) the Dwyer (1982) and Hoelscher (1983) analyses are merely ‘static’, i.e., deal with only the level of interest rates, whereas the present analysis deals with ‘dynamic’ variables, i.e., rates of change. In any event, it appears — in contrast to Dwyer (1982) and Hoelscher (1983) — that financial crowding out is a fact of life and that deficits do indeed matter. Copyright Martinus Nijhoff Publishers 1985