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Deficit-related explanations for the US interest rate conundrum

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  • Harrison Hartman

Abstract

This study offers two potential explanations related to the United States federal budget deficit for the recent interest-rate puzzle in the USA where long-term rates have fallen while short-term rates have risen. A VAR quantifies the relationships between real deficits, real GDP growth rates and ex ante real long-term rates. Impulse-response functions show the assumed time-invariant responses of real GDP and long-term real interest rates to a one-standard-deviation increase in the real deficit, providing some support for the crowding out theory but possibly also the crowding in theory in the short term. Findings include that expectations of future deficits could impact real interest rates today. This study notes that the interest-rate impact of expected changes in deficits is unclear because the changes in rates due to changes in (1) federal borrowing and (2) forecasted GDP growth would be in opposite directions, assuming that crowding out occurs at some point. Thus, it is not clear whether reductions in long-term rates imply that people expect larger or smaller budget deficits in the future.

Suggested Citation

  • Harrison Hartman, 2007. "Deficit-related explanations for the US interest rate conundrum," Applied Economics Letters, Taylor & Francis Journals, vol. 14(4), pages 261-265.
    • Handle: RePEc:taf:apeclt:v:14:y:2007:i:4:p:261-265
    DOI: 10.1080/13504850500447422
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    References listed on IDEAS

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    1. MacKinnon, James G, 1996. "Numerical Distribution Functions for Unit Root and Cointegration Tests," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(6), pages 601-618, Nov.-Dec..
    2. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-1072, June.
    3. Samih Antoine Azar, 2005. "Econometric diagnostics to distinguish between the IS curve and the Ricardian equivalence," Applied Economics, Taylor & Francis Journals, vol. 37(1), pages 93-98.
    4. Ali Darrat, 2002. "On Budget Deficits And Interest Rates: Another Look At The Evidence," International Economic Journal, Taylor & Francis Journals, vol. 16(2), pages 19-29.
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    2. Oseni O. Isiaq & Adesoye A. Bolaji, 2016. "Fiscal Policy and Term Structure of Interest Rate in Nigeria," EuroEconomica, Danubius University of Galati, issue 2(12), pages 70-83, April.
    3. Yu Hsing, 2010. "Government Borrowing And The Longterm Interest Rate: Application Of An Extended Loanable Funds Model To The Slovak Republic," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 55(184), pages 58-70, January –.
    4. Daniel Choi & Mark Holmes, 2014. "Budget deficits and real interest rates: a regime-switching reflection on Ricardian Equivalence," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 38(1), pages 71-83, January.
    5. Zhipeng Han & Liguo Wang & Feifei Zhao & Zijun Mao, 2022. "Does Low-Carbon City Policy Improve Industrial Capacity Utilization? Evidence from a Quasi-Natural Experiment in China," Sustainability, MDPI, vol. 14(17), pages 1-26, September.

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