An Investigation into the Impact of Federal Government Budget Deficits on the Ex Ante Real Interest Rate Yield on Treasury Notes in the U.S.

Cebula, Richard (2014): An Investigation into the Impact of Federal Government Budget Deficits on the Ex Ante Real Interest Rate Yield on Treasury Notes in the U.S.

Abstract

Using four decades of data, this empirical study adopts a loanable funds model to investigate the impact of the federal government budget deficit in the U.S. on the ex ante real interest rate yield on ten-year Treasury notes. For the 40-year period 1973-2012, an autoregressive 2SLS estimate finds that the ex ante real interest rate yield on ten-year U.S. Treasury notes was an increasing function of the ex ante real interest rate yield on Moody’s Aaa-rated corporate bonds, the ex ante real interest rate yield on three-month Treasury bills, and the increase in per capita real GDP, while being a decreasing function of net capital inflows (as a percent of GDP), which are treated as endogenous, and the monetary base (as a percent of GDP). In addition, it is found that that the federal budget deficit (relative to the GDP level) exercised a positive and statistically significant impact on the ex ante real interest rate yield on ten-year Treasury notes, a finding consistent in principle with a number of prior studies of other interest rate measures during shorter and earlier time periods. A modest robustness test using the ex ante real seven-year Treasury note yield generates the same conclusions.

• Item Type: MPRA Paper
• Language: English
• Keywords: budget deficits; ex ante real interest rates; international capital flows
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E42 - Monetary Systems ; Standards ; Regimes ; Government and the Monetary System ; Payment Systems; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; H - Public Economics > H6 - National Budget, Deficit, and Debt > H62 - Deficit ; Surplus

References

Barth, J.R., Iden, G., Russek, F.S. (1985). Federal borrowing and short term interest rates: Comment. Southern Economic Journal 52: 554-559.

Barth, J.R., Iden, G., Russek, F.S. (1986). Government debt, government spending, and private sector behavior: Comment. American Economic Review 76: 1115-1120.

Carlson, K.M., and Spencer, R.W. (1975). Crowding out and its critics. Federal Reserve Bank St. Louis Review 57: 1-19.

Cebula, R.J. (1997). An empirical note on the impact of the federal budget deficit on ex ante real long term interest rates, 1973-1995. Southern Economic Journal 63: 1094-1099.

Cebula, R.J. (2013). An exploratory inquiry into the impact of budget deficits on the nominal interest rate yield on Moody’s Aaa-rated corporate bonds. Applied Economics Letters 20: 1497-1500.

Cebula, R.J. (2005). Recent evidence on the impact of the primary deficit on nominal long term Treasury note interest rate yields. Global Business & Economics Review 7: 47-58.

Cebula, R.J., Cuellar, P. (2010). Recent evidence on the impact of government budget deficits on the ex ante real interest rate yield on Moody’s Aaa-rated corporate bonds. Journal of Economics and Finance 34: 301-307.

Day, A.E. (1992). Federal government budget deficits and interest rates: Comment. Southern Economic Journal 56: 816-820.

Ewing, B.T., Yanochik, M.A. (1999),.Budget deficits and the term structure of interest rates in Italy. Applied Economics Letters 6: 199-201.

Findlay, D.W. (1990). Budget deficits, expected inflation, and short term real interest rates. International Economic Journal 4: 41-53.

Gissey, W. (1999). Net Treasury borrowing and interest rate changes. Journal of Economics and Finance 23: 211-219.

Hoelscher, G. (1986). New evidence on deficits and interest rates. Journal of Money, Credit and Banking 18: 1-17.

Holloway, T.M. (1986). The cyclically adjusted federal budget and federal debt: Revised and updated estimates. Survey of Current Business 66: 11-17 . Holloway, T.M. (1988). The relationship between federal deficit/debt and interest rates. The American Economist 32: 29-38.

Johnson, C.F. (1992). An empirical note on interest rate equations. Quarterly Review of Economics and Finance 32: 141-147.

Newey W.K., West K.D. (1987). A simple positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica 55: 703-708.

Ostrosky, A.L. (1990). Federal budget deficits and interest rates: Comment. Southern Economic Journal 56: 802-803.