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Federal budget deficits and long-term interest rates in USA

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  • Kiani, Khurshid M.

Abstract

We investigate whether the emergence of high inflation rates after 1965 and large budget deficits after 1980s caused the financial market agents to become more sensitive to the outlooks for inflation and budget deficits. Our approach is parametric and our models fully account for possible presence of ARCH effects in the data. Our results show a statistically significant positive link between the budget deficits and the slope of the yield curve which is more pronounced in the later sub-sample period. These results are in line with Reinhard and Sack [Reinhard, V., & Sack, B. (2000). The economic consequences of disappearing government debt. Brooking Papers of Economic Activity, 163-209] but in sharp contrast with Evans [Evans, P. (1985). Do large deficits produce high interest rates? American Economic Review, 7, 68-87] and Evans [Evans, P. (1987). Do budget deficits raise nominal interest rates? Journal of Monetary Economics, 20, 281-300].

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Bibliographic Info

Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

Volume (Year): 49 (2009)
Issue (Month): 1 (February)
Pages: 74-84

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Handle: RePEc:eee:quaeco:v:49:y:2009:i:1:p:74-84

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Web page: http://www.elsevier.com/locate/inca/620167

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Keywords: Budget deficits Inflation Long-term interest rates Short-term interest rates Yield curve;

References

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  1. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
  2. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  3. Pagan, A.R. & Schwert, G.W., 1989. "Alternative Models For Conditional Stock Volatility," Papers 89-02, Rochester, Business - General.
  4. Mascaro, Angelo & Meltzer, Allan H., 1983. "Long- and short-term interest rates in a risky world," Journal of Monetary Economics, Elsevier, vol. 12(4), pages 485-518, November.
  5. Echols, Michael E & Elliott, Jan Walter, 1976. "Rational Expectations in a Disequilibrium Model of the Term Structure," American Economic Review, American Economic Association, vol. 66(1), pages 28-44, March.
  6. Vincent Reinhart & Brian Sack, 2000. "The Economic Consequences of Disappearing Government Debt," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 163-220.
  7. Evans, Paul, 1987. "Do budget deficits raise nominal interest rates? : Evidence from six countries," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 281-300, September.
  8. Cebula, Richard J. & Rhodd, Rupert G., 1993. "A note on budget deficits, debt service payments, and interest rates," The Quarterly Review of Economics and Finance, Elsevier, vol. 33(4), pages 439-445.
  9. Hoelscher, Gregory, 1986. "New Evidence on Deficits and Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(1), pages 1-17, February.
  10. Lloyd B. Thomas, 1999. "Survey Measures of Expected U.S. Inflation," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 125-144, Fall.
  11. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  12. Makin, John H, 1983. "Real Interest, Money Surprises, Anticipated Inflation and Fiscal Deficits," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 374-84, August.
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Cited by:
  1. Alexander, Gigi & Foley, Maggie, 2014. "On the Nominal Interest Rate Yield Response to Net Government Borrowing in the U.S.: An Empirical Analysis with Robustness Tests," MPRA Paper 56968, University Library of Munich, Germany.
  2. Luca Agnello & Ricardo M. Sousa, 2010. "Fiscal Policy and Asset Prices," NIPE Working Papers 25/2010, NIPE - Universidade do Minho.
  3. Cebula, Richard, 2014. "Current Evidence on the Impact of Budget Deficits on the Nominal Interest Rate Yield on Intermediate-term Debt Issues of the U.S. Treasury: An Analysis with Robustness Tests," MPRA Paper 55923, University Library of Munich, Germany.

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