Effects of Fiscal Policy on Credit Markets

Abstract

Credit markets typically freeze in recessions: access to credit declines, and the cost of credit increases. A conventional policy response is to rely on monetary tools to saturate financial markets with liquidity. Given limited space for monetary policy in the current economic conditions, we study how fiscal stimulus can influence local credit markets. Using rich geographical variation in US federal government contracts, we document that, in a local economy, interest rates on consumer loans decrease in response to an expansionary government spending shock.

Do Credit Markets Respond to Macroeconomic Shocks? The Case for Reverse Causality

“…Indeed, our results imply feedback from the macroeconomy to credit conditions and are therefore also useful to understand the propagation of credit shocks. Our results on government spending shocks and corporate bond credit spreads are consistent with Auerbach, Gorodnichenko, and Murphy (2020), who document that positive fiscal policy shocks, in the form of Department of Defense contracts, lower consumer borrowing rates. While Auerbach, Gorodnichenko, and Murphy (2020) conclude that lower consumer credit risk premia “possibly” contribute to this response, we quantify the exact contribution of credit risk premia.…”

“…Our results on government spending shocks and corporate bond credit spreads are consistent with Auerbach, Gorodnichenko, and Murphy (2020), who document that positive fiscal policy shocks, in the form of Department of Defense contracts, lower consumer borrowing rates. While Auerbach, Gorodnichenko, and Murphy (2020) conclude that lower consumer credit risk premia “possibly” contribute to this response, we quantify the exact contribution of credit risk premia. Finally, the causal effect of IST news on credit spreads contributes to a growing body of work that emphasizes the importance of investment‐specific technology shocks in asset pricing (Kogan and Papanikolaou (2013, 2014)) and macroeconomics (Fisher (2006), Ben Zeev and Khan (2015)).…”

Macroprudential Policy Effects

“…However, empirical evidence fails to support this prediction (Fisher andPeters 2010, Ramey 2011). Expansionary government spending shocks may lower interest rates, possibly because of higher credit supply associated with higher liquidity and lower riskiness of borrowers (Auerbach, Gorodnichenko, and Murphy 2020). Also, government spending can relax firms' borrowing constraints in line with the financial accelerator mechanism (Hebous and Zimmermann 2021).…”