New Evidence on the Interest Rate Effects of Budget Deficits and Debt

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 abstract from 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 expected government debt and deficits, measured by CBO and OMB projections, and expected future long-term interest rates. The estimated effects of government debt and deficits on interest rates are statistically and economically significant: a one percentage point increase in the projected deficit-to-GDP ratio is estimated to raise long-term interest rates by roughly 25 basis points. Under plausible assumptions these estimates are shown to be consistent with predictions of the neoclassical growth model. JEL classification: E6, H6.

Bond yields in emerging economies: It matters what state you are in

“…Gale and Orszag (2003) report that out of 59 studies, 29 find that weaker fiscal variables increase interest rates, while 11 had mixed results and 19 found that the effect was not significant. Moreover, a majority of studies finds that the effect of fiscal policy on interest rates is larger when the fiscal deficit rather than public debt is included as an explanatory variable (Faini, 2006;Laubach, 2009). In addition, the effects of fiscal policy are larger when expectations of future fiscal policy rather than actual values of the debt and deficit are used (Laubach, 2009) and when single country studies rather than cross country studies are performed.…”

“…Moreover, a majority of studies finds that the effect of fiscal policy on interest rates is larger when the fiscal deficit rather than public debt is included as an explanatory variable (Faini, 2006;Laubach, 2009). In addition, the effects of fiscal policy are larger when expectations of future fiscal policy rather than actual values of the debt and deficit are used (Laubach, 2009) and when single country studies rather than cross country studies are performed. The estimated impact on interest rates of a change of one percent of GDP in the fiscal deficit ranges from 10 basis points to 60 basis points (Laubach, 2009).…”

“…In addition, the effects of fiscal policy are larger when expectations of future fiscal policy rather than actual values of the debt and deficit are used (Laubach, 2009) and when single country studies rather than cross country studies are performed. The estimated impact on interest rates of a change of one percent of GDP in the fiscal deficit ranges from 10 basis points to 60 basis points (Laubach, 2009).…”

“…Following Laubach (2009), and in order to avoid potential endogeneity issues, we use market expectations of the fiscal variables, real GDP growth and inflation. We also include a measure of the short-term nominal interest rate to control for the effects of monetary policy on the term structure and the U.S. long-term bond yield to account for global liquidity conditions.…”

Does investment in the health sector promote or inhibit economic growth?

“…Much of the discussion has centred on the question of whether government spending will promote [1][2][3] or inhibit economic growth [4,5]. Critics of government spending argue, first, that such spending has an immediate effect of increasing debt which, if associated with a loss of confidence by investors, will also increase the cost of servicing that debt as a consequence of increased interest rates [6,7]. Second, they argue that, by "crowding out" private markets and, by implication, their assumed greater efficiency, they will inhibit the growth necessary for recovery [8].…”