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The effects of deficit-reduction laws on real interest rates

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Author Info

  • Douglas W. Elmendorf

Abstract

This paper uses news reports about two deficit-reduction laws of the past decade to identify days when expected fiscal policy clearly became more or less expansionary. The paper also proposes a technique for identifying whether the real interest rate increased or decreased on those days, based on changes in the nominal interest rate, the exchange rate, commodity prices, and stock prices. As economic theory predicts, higher expected government spending and budget deficits raised real interest rates and the value of the dollar, while lower expected spending and deficits reduced real rates and the value of the dollar.

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File URL: http://www.federalreserve.gov/pubs/feds/1996/199644/199644abs.html
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File URL: http://www.federalreserve.gov/pubs/feds/1996/199644/199644pap.pdf
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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 96-44.

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Date of creation: 1996
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Handle: RePEc:fip:fedgfe:96-44

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Related research

Keywords: Budget deficits ; Expenditures; Public ; Interest rates;

References

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  1. Elmendorf, D.W., 1993. "Actual Budget Deficit Expectations and Interest Rates," Harvard Institute of Economic Research Working Papers 1639, Harvard - Institute of Economic Research.
  2. B. Douglas Bernheim, 1987. "Ricardian Equivalence: An Evaluation of Theory and Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1987, Volume 2, pages 263-316 National Bureau of Economic Research, Inc.
  3. Wachtel, Paul & Young, John, 1987. "Deficit Announcements and Interest Rates," American Economic Review, American Economic Association, vol. 77(5), pages 1007-12, December.
  4. James M. Poterba, 1986. "Explaining the Yield Spread between Taxable and Tax-exempt Bonds : The Role of Expected Tax Policy," NBER Chapters, in: Studies in State and Local Public Finance, pages 5-52 National Bureau of Economic Research, Inc.
  5. Laurence Ball & N. Gregory Mankiw, 1995. "What do Budget Deficits Do?," Harvard Institute of Economic Research Working Papers 1740, Harvard - Institute of Economic Research.
  6. Summers, Lawrence H. & Cutler, David, 1988. "The Costs of Conflict Resolution and Financial Distress: Evidence from the Texaco-Pennzoil Litigation," Scholarly Articles 2689179, Harvard University Department of Economics.
  7. Leamer, Edward E., 1985. "Vector autoregressions for causal inference?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 255-304, January.
  8. Evans, Paul, 1986. "Is the dollar high because of large budget deficits?," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 227-249, November.
  9. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-22, September.
  10. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  11. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  12. Reischauer, Robert D., 1990. "Taxes and Spending Under Gramm-Rudman-Hollings," National Tax Journal, National Tax Association, vol. 43(3), pages 223-32, September.
  13. Evans, Paul, 1987. "Interest Rates and Expected Future Budget Deficits in the United States," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 34-58, February.
  14. Blanchard, Olivier J, 1981. "Output, the Stock Market, and Interest Rates," American Economic Review, American Economic Association, vol. 71(1), pages 132-43, March.
  15. Plosser, Charles I., 1987. "Fiscal policy and the term structure," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 343-367, September.
  16. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  17. Dominguez, Kathryn M & Frankel, Jeffrey A, 1993. "Does Foreign-Exchange Intervention Matter? The Portfolio Effect," American Economic Review, American Economic Association, vol. 83(5), pages 1356-69, December.
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Citations

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Cited by:
  1. Lei Lei Song & John Freebairn, 2004. "ow Big Was the Effect of Budget Consolidation on the Australian Economy in the 1990s?," Melbourne Institute Working Paper Series wp2004n30, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  2. Thomas Laubach, 2003. "New evidence on the interest rate effects of budget deficits and debt," Finance and Economics Discussion Series 2003-12, Board of Governors of the Federal Reserve System (U.S.).
  3. Garima Vasishtha & Taimur Baig & Manmohan S. Kumar & Edda Zoli, 2006. "Fiscal and Monetary Nexus in Emerging Market Economies," IMF Working Papers 06/184, International Monetary Fund.
  4. Kameda, Keigo, 2014. "Budget deficits, government debt, and long-term interest rates in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 32(C), pages 105-124.
  5. Eric M. Engen & R. Glenn Hubbard, 2004. "Federal Government Debt and Interest Rates," NBER Working Papers 10681, National Bureau of Economic Research, Inc.
  6. Kitchen, John, 2002. "A Note on Interest Rates and Structural Federal Budget Deficits," MPRA Paper 21069, University Library of Munich, Germany, revised Oct 2002.

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