Government spending or deficit financing: which causes crowding out?

Abstract

Economists have different opinions about the impact of federal deficits on interest rates. One reason for this difference is confusion about the effects of changes in government spending and the effects of how the spending is financed. A simple dynamic model is used to demonstrate that although increases in government spending increase interest rates, increases in the bond stock, by themselves, do not. In addition, the response of the monetary authority to the fiscal change is incorporated in the model.