Can an Increase in Government Spending Lower Local Interest Rates?
Rising Department of Defense outlays in a community are associated with lower auto and home equity loan rates, perhaps because they increase expected future income and wealth.
Textbook macroeconomic theory holds that unless there are slack resources in the economy, an increase in government spending will put upward pressure on interest rates, thereby lowering consumer spending and business investment. But new empirical findings suggest that, at least at the local level, higher government spending actually may lead to a decline in interest rates.
Wage Effects of R&D Grants to Small Private High-Tech Firms
The researchers examine the effect of US Department of Defense (DOD) contracts on the interest rates prevailing in the cities in which the contract work was performed. Although US credit markets are integrated, local banks set their own rates for consumer loans. The researchers find that a 1 percent increase in expected DOD outlays from ongoing contracts, which may be interpreted as an injection of liquidity, is associated with a 0.24 basis point reduction in auto loan rates and a 0.30 basis point reduction in the rates charged for home equity lines of credit with a high loan-to-value ratio. In contrast, outlays associated with new production contracts have interest rate effects on auto loans that are an order of magnitude higher, with rates declining by 1.26 basis points in response to a 1 percent increase. The effect of new contracts on mortgage loan rates was small, and there was no statistically significant effect on credit card rates.
— Linda Gorman
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