Government Deficit and Substitutability between Debt Instruments

This paper provides theoretical and empirical analysis for the issue of crowding out when a distinction is noted between bonds and loans as debt instrument. It turns out that there exists additional crowding out with the introduction of loans, which are not perfect substitutes of bonds. It is shown that the differential impact on asset returns of the fiscal policy depends upon the degree of substitutability between the financial assets. Namely, the higher the degree of substitutability between money and bonds is and the lower the degree of substitutability between loans and bonds is, the greater the level of crowding out is.