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Federal Budget Deficits, Interest Rates, and Inflation: Their Implication for Growth


  • Peter J. Saunders

    (Central Washington University)


The persistence of large federal government deficits has stimulated interest in investigating the impact of deficits on the U.S. economy. The present paper analyzes two related theoretical issues. First, it examines the direction of causal flows in the deficit-nominal interest rate relationship. Second, it investigates the effects of deficits on the two components of nominal interest rates, namely the inflation rate and the real rate of interest. The causality test results indicate that deficits affect both of these components in the case of the long-term nominal interest rate. Deficits have adverse effects on economic growth because of reduced capital formation at higher real rates of interest.

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  • Peter J. Saunders, 1989. "Federal Budget Deficits, Interest Rates, and Inflation: Their Implication for Growth," Eastern Economic Journal, Eastern Economic Association, vol. 15(3), pages 213-219, Jul-Sep.
  • Handle: RePEc:eej:eeconj:v:15:y:1989:i:3:p:213-219

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    References listed on IDEAS

    1. Ram, Rati, 1984. "Causal Ordering across Inflation and Productivity Growth in the Post-war United States," The Review of Economics and Statistics, MIT Press, vol. 66(3), pages 472-477, August.
    2. William G. Dewald, 1982. "Disentangling monetary and fiscal policy," Economic Review, Federal Reserve Bank of San Francisco, issue Win, pages 7-18.
    3. Ahking, Francis W. & Miller, Stephen M., 1985. "The relationship between government deficits, money growthm and inflation," Journal of Macroeconomics, Elsevier, vol. 7(4), pages 447-467.
    4. Allen, Stuart D. & Smith, Michael D., 1983. "Government borrowing and monetary accommodation," Journal of Monetary Economics, Elsevier, vol. 12(4), pages 605-616, November.
    5. Levy, Mickey D., 1981. "Factors affecting monetary policy in an era of inflation," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 351-373.
    6. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-438, July.
    7. Blinder, Alan S. & Solow, Robert M., 1973. "Does fiscal policy matter?," Journal of Public Economics, Elsevier, vol. 2(4), pages 319-337.
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