NEW EVIDENCE ON THE INTEREST RATE EFFECTS OF BUDGET DEFICITS AND DEBT

Authors


laubach@wiwi.uni-frankfurt.de

Abstract

Estimating the effects of government debt and deficits on Treasury yields is complicated by the need to isolate the effects of fiscal policy from other influences. To control for the effects of the business cycle, and associated monetary policy actions, on debt, deficits, and interest rates, this paper studies the relationship between long-horizon forward rates and future federal government deficits and debt as projected by the Congressional Budget Office. For the entire 30-year sample for which these projections are available, the estimated effects of government deficits and debt on interest rates are statistically significant and economically relevant: about 25 basis points per percentage point increase in the projected deficit/GDP ratio, and 3 to 4 basis points for the debt/GDP ratio. Under plausible assumptions the parameter estimates are shown to be consistent with predictions from the neoclassical growth model. (JEL: E6, H6)

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