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The effects of deficit-reduction laws on real interest rates

  • Douglas W. Elmendorf

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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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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  1. Evans, Paul, 1986. "Is the dollar high because of large budget deficits?," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 227-249, November.
  2. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  3. Reischauer, Robert D., 1990. "Taxes and Spending Under Gramm-Rudman-Hollings," National Tax Journal, National Tax Association, vol. 43(3), pages 223-32, September.
  4. David M. Cutler & Lawrence H. Summers, 1987. "The Costs of Conflict Resolution and Financial Distress: Evidence from the Texaco-Pennzoil Litigation," NBER Working Papers 2418, National Bureau of Economic Research, Inc.
  5. Elmendorf, D.W., 1993. "Actual Budget Deficit Expectations and Interest Rates," Harvard Institute of Economic Research Working Papers 1639, Harvard - Institute of Economic Research.
  6. 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.
  7. B. Douglas Bernheim, 1987. "Ricardian Equivalence: An Evaluation of Theory and Evidence," NBER Working Papers 2330, National Bureau of Economic Research, Inc.
  8. Plosser, Charles I., 1987. "Fiscal policy and the term structure," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 343-367, September.
  9. Laurence Ball & N. Gregory Mankiw, 1995. "What do budget deficits do?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 95-119.
  10. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
  11. 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.
  12. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  13. Leamer, Edward E., 1985. "Vector autoregressions for causal inference?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 255-304, January.
  14. 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.
  15. 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.
  16. Blanchard, Olivier J, 1981. "Output, the Stock Market, and Interest Rates," American Economic Review, American Economic Association, vol. 71(1), pages 132-43, March.
  17. Wachtel, Paul & Young, John, 1987. "Deficit Announcements and Interest Rates," American Economic Review, American Economic Association, vol. 77(5), pages 1007-12, December.
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