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Deficits and long-term interest rates: an empirical note

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  • Yash P. Mehra

Abstract

This note examines whether long-term nominal interest rates are cointegrated with budget deficits over the period 1959 to 1990. A key finding of this note is that long-term rates are cointegrated with deficits if a one-year ahead inflation forecast series is used to measure long-term expected inflation. However, the evidence favoring cointegration between deficits and interest rates weakens and almost disappears when inflation forecasts over longer horizons (2 to 4 years) are used. This result indicates that a one-year ahead inflation forecast series does not adequately measure long-term expected inflation. Hence, the link found between deficits and long-term rates using one-year inflation forecast series is spurious.

Suggested Citation

  • Yash P. Mehra, 1992. "Deficits and long-term interest rates: an empirical note," Working Paper 92-02, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:92-02
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    References listed on IDEAS

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    1. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
    2. Plosser, Charles I., 1982. "Government financing decisions and asset returns," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 325-352.
    3. Thomas J. Sargent, 1969. "Commodity Price Expectations and the Interest Rate," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 83(1), pages 127-140.
    4. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
    5. Robert Engle & Clive Granger, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 39(3), pages 106-135.
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    1. repec:spo:wpecon:info:hdl:2441/1482 is not listed on IDEAS
    2. repec:spo:wpmain:info:hdl:2441/1769 is not listed on IDEAS
    3. Bruno Ducoudré, 2005. "Fiscal policy and interest rates," Documents de Travail de l'OFCE 2005-08, Observatoire Francais des Conjonctures Economiques (OFCE).
    4. Jérôme Creel & Bruno Ducoudré & Catherine Mathieu & Henri Sterdyniak, 2005. "Doit-on oublier la politique budgétaire ?. Une analyse critique de la nouvelle théorie anti-keynésienne des finances publiques," Revue de l'OFCE, Presses de Sciences-Po, vol. 92(1), pages 43-97.
    5. repec:spo:wpecon:info:hdl:2441/1769 is not listed on IDEAS
    6. Jean‐Paul Fitoussi & Francesco Saraceno, 2008. "Fiscal Discipline as a Social Norm: The European Stability Pact," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(6), pages 1143-1168, December.

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