Government Spending and Interest Rates

45 Pages Posted: 22 Jul 2015 Last revised: 14 Mar 2020

See all articles by Daniel Murphy

Daniel Murphy

University of Virginia - Darden School of Business

Kieran James Walsh

University of California, Santa Barbara (UCSB) - Department of Economics

Date Written: March 11, 2020

Abstract

Most macroeconomic models imply that increases in government spending cause interest rates to rise, but empirical evidence from the U.S. generally fails to support this prediction. We propose a novel explanation for how government spending can have a muted or negative temporary effect on interest rates: the increased supply of loans associated with government spending is offset by an increase in the demand for loans due to higher aggregate income. We demonstrate this mechanism theoretically and provide evidence consistent with the model's predictions.

Keywords: Interest Rates, Fiscal Policy, Aggregate Demand,

JEL Classification: E21, E41, E42, E43, E44, E62, F34

Suggested Citation

Murphy, Daniel and Walsh, Kieran James, Government Spending and Interest Rates (March 11, 2020). Darden Business School Working Paper No. 2634141. Available at SSRN: https://ssrn.com/abstract=2634141 or http://dx.doi.org/10.2139/ssrn.2634141

Daniel Murphy

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

Kieran James Walsh (Contact Author)

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

Santa Barbara, CA

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