Budget Balance Deficit Thresholds and Their Macroeconomic Impact

What are the macroeconomic effects of budget deficits? Do budget deficit thresholds matter? We find that the yield on the ten-year government bond increases in response to positive budget balance shocks. Real output growth, investment growth, and employment growth decline in response to positive budget balance shocks. The rnad per US dollar (R/US$) exchange rate depreciates in response to positive shocks to the budget balance as a ratio of nominal GDP and inflation increases. As a result , the exchange rate channel is one of the channels through which inflation increases in response to positive shocks to the budget balance as a ratio of nominal GDP. Furthermore, evidence shows that the ten-year government bond yields decline, output growth, investment growth and employment growth increase, the R/US$ exchange rate appreciates, and inflation declines in the low budget deficit regime. The opposite is true in the high budget deficit regimes and these results are robust to using the different thresholds to demarcate low and high budget deficit regimes. These results imply that the potency of fiscal deficit-driven stimulus is highly dependent on budget deficit thresholds. Beyond a certain threshold, budget deficits have adverse effects on bond yields, the exchange, and inflation. In addition, such a fiscal policy stance can prove to be detrimental to the mandates of price and financial and macroeconomic stability.