Financial Crowding Out

Using a novel dataset of accounting and market information that spans most publicly traded firms over the last century, we show that government deficit financing crowds out nonfinancial corporate debt financing and investment. Specifically, an increase in the supply of treasury debt is associated with a significant reduction in corporate leverage, debt issuances, and investment, but no significant change in corporate equity issuances. Further, this crowding out effect is present across industries and is more pronounced for larger, less risky firms whose debt is a closer substitute for treasuries. The channel through which this effect appears to operate is financial intermediaries, whose balance sheets reveal a substitution between lending to the federal government and lending to the corporate sector.