This article empirically investigates the impact of the federal budget deficit on the real interest-rate yield on high-grade, long-term municipal bonds. The model uses
quarterly data and covers the period 1971:4 through 1985:4. Estimating in first-difference form by instrumental variables, it is found that the federal budget deficit
does, in fact, elevate the real municipal bond rate. This finding implies at least some
degree of crowding out of the state and local government sectors.
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