Abstract
Using error-correction model (ECM) estimation, the paper empirically examines the causality relationship between the federal government budget deficit and the ex ante real interest rate yield on high grade long term tax free municipal bonds in the U.S. To clarify this deficit or interest rate relationship, the budget deficit is measured by the primary budget deficit, which excludes net interest payments by the Treasury. In a model that includes federal personal income tax rates and net international capital flows, as well as money supply growth, the ECM estimates strongly suggest a bi-directional relationship between the primary budget deficit and the ex ante real interest rate yield. Budget deficits apparently do matter! William Simon's concerns were justified.
Similar content being viewed by others
References
Al-Saji, Amer K. “Government Budget Deficits, Nominal, and Ex Ante Real Long Term Interest Rates in the U.K.: 1960.1–1990.2,”Atlantic Economic Journal, 21, 1993, pp. 71–7.
Barth, James R.; Iden, George; Russek, Frank S. “Do Federal Deficits Really Matter?”Contemporary Policy Issues, 3, 1985, pp. 79–95.
Barth, James R. “Federal Borrowing and Short Term Interest Rates: Comment,”Southern Economic Journal, 52, 1985, pp. 554–59.
——; Wohar, Mark. Effects of Federal Budget Deficits on Interest Rates and the Composition of Domestic Output, Washington, D.C.: The Urban Institute, 1989.
Board of Governors of the Federal Reserve System. 1973–2002; federalreserve.gov/Releases/H15/data
Brookings Institution, Urban Institute. 2002, Tax Facts; taxpolicycenter.org/TaxFacts/individual/schedule.cfm
Bureau of Labor Statistics. 2002; bea.doc.gov/bea/dn/nipawweb/SelectTable.asp?Selected=N
Carlson, Keith M.; Spencer, Robert W. “Crowding Out and Its Critics,”Federal Reserve Bank of St. Louis Review, 60, 1975, pp. 1–19.
Cebula, Richard J. “Central Government Budget Deficits and Ex Ante Real Long Term Interest Rates in Italy: An Empirical Note for 1955–89,”Metroeconomica, 43, 1992, pp. 397–402.
—— “The Crowding Out Effect of Fiscal Policy,”Kyklos, 38, 1985, pp. 435–8.
—— “An Empirical Note on the Impact of the Federal Budget Deficit on Ex Ante Real Long-Term Interest Rates, 1973–95,”Southern Economic Journal, 63, 1997, pp. 1094–99.
—— “Federal Government Budget Deficits and Interest Rates: An Analysis for the United States, 1955–1984,”Public Finance or Finances Publiques, 43, 1988. pp. 337–48.
—— “Federal Government Budget Deficits and Real Municipal Bond Yields,”Public Finance Review, 19, 1991, pp. 437–43.
—— “Federal Government Fiscal Actions and the Cost of Municipal Borrowing: An Empirical Note,”Quarterly Review of Economics and Business, 30, 1990, pp. 102–7.
—— “The Impact of Structural Budget Deficits on Commercial Bank Interest Rates: Reply,”Public Finance Review, 28, 2000, 195–8.
——; Belton, Willie J. “Government Budget Deficits and Interest Rates in the United States: Evidence for Closed and Open Economies Put into Perspective,”Public Finance or Finances Publiques, 48, 1993, pp. 188–209.
——; Rhodd, Ruppert. “A Note on Budget Deficits, Debt Service Payments, and Interest Rates,”Quarterly Review of Economics and Finance, 33, 1993, pp. 439–45.
Congressional Budget Office.The Economic and Budget Outlook: Fiscal Years 1988–1992, Annual Report, Washington, DC: US. GPO, 1987.
Council of Economic Advisors.Economic Report of the President, Washington, D.C.: U.S. Government Printing Office, 1974–2002.
Cukierman, Alex; Meltzer, Allan, H. “A Political Theory of Government Debt and Deficits in a Neo-Ricardian Framework,”American Economic Review, 79, 1983, pp. 713–32.
Darrat, Ali F. “Do Structural Budget Deficits Impact Commercial Bank Interest Rates? A Comment,”Public Finance Review, 28, 2000, pp. 194–7.
Evans, Paul. “Do Large Deficits Produce High Interest Rates?”American Economic Review, 75, 1985, pp. 68–87.
——. “Interest Rates and Expected Future Deficits in the United States,”Journal of Political Economy, 95, 1987, pp. 34–55.
Feige, Edgar L. “The Underground Economy and the Currency Enigma,”Public Finance or Finances Publiques, 49, 1994, pp. 119–36.
Feldstein, Martin; Eckstein, Otto. “The Fundamental Determinants of the Interest Rate,”Review of Economics and Statistics, 52, 1970, pp. 362–75.
Findlay, Donald W. “Budget Deficits, Expected Inflation, and Short-Term Real Interest Rates,”International Economic Journal, 4, 1990, pp. 41–53.
Findlay, Donald W. “Federal Borrowing and Short term Interest Rates,”Southern Economic Journal, 50, 1983, pp. 319–33.
——. “New Evidence on Deficits and Interest Rates,”Journal of Money, Credit, and Banking, 18, 1986, pp. 1–17.
Holloway, Thomas M. “The Cyclically Adjusted Federal Budget and Federal Debt: Revised and Updated Estimates,”Survey of Current Business, 66, 1986, pp. 11–7.
—— “The Relationship between Federal Deficit or Debt and Interest Rates,”The American Economist, 32, 1988. pp. 29–38.
Johansen, Soren. “Maximum Likelihood Estimation and Inference on Cointegration—with Applications to the Demand for Money,”Oxford Bulletin of Economics and Statistics, 54, 1990, pp. 169–210.
Johnson, Colleen F. “An Empirical Note on Interest Rate Equations,”Quarterly Review of Economics and Finance, 32, 1992, pp. 141–47.
Mascaro, Angelo; Meltzer, Allan H. “Long and Short Term Interest Rates in a Risky World,”Journal of Monetary Economics, 20, 1983, pp. 151–200.
Mayer, Thomas S.The Political Economy of American Monetary Policy, Cambridge: Cambridge University Press, 1990.
McMillin, Douglas W. “Federal Deficits and Short Term Interest Rates,”Journal of Macroeconomics, 8, 1986, pp. 403–22.
Orcutt, Bonnie L. “Expenditure and Deficit Policy: A Retrospective Look at the Simon Agenda,” International Atlantic Economic Society, Washington, D.C., 2002.
Ostrosky, Anthony L. “Federal Budget Deficits and Interest Rates:Comment,”Southern Economic Journal, 56, 1990, pp. 802–3.
Ott, Attiat F.Public Sector Budgets: A Comparative Study, Aldershot, UK: Edward Elgar Publishing Ltd., 1993.
Penner, Rudolph G. “Government Deficits: The Case of the United States,” in Boskin, Michael J.; Flemming, John S., eds., Private Savings and Public Debt, New York: Basil Blackwell, 1987, pp. 105–25.
Saltz, Ira S. “Ex Ante Real Long-term Interest rates and U.S. federal Budget Deficits: Preliminary Error-Correction Evidence,”Economia Internazionale, 51, 1988, pp. 163–9.
——Financial Economics, New York: Pearson Publishing Co., 1999.
Swamy, P. A. V. B.; Kolluri, B. R.; Singamsetti, R. N. “What Do Regressions of Interest Rates on Deficits Imply?”Southern Economic Journal, 56, 1990, pp. 1010–28.
Tanzi, Vito. “Fiscal Deficits and Interest Rates in the United States,” I.M.F. Staff Papers, 1985, pp. 551–76.
——.The Underground Economy in the United States and Abroad, Lexington, MA: Lexington Books, 1982.
——. “The Underground Economy in the United States: Annual Estimates, 1930–1980,” I.M.F. Staff Papers, 30, 1983, pp. 283–305.
Thies, Clifford. “Business Price Expectations, 1947–84,”Journal of Money, Credit, and Banking, 18, 1986, pp. 336–54.
U.S. Department of Commerce.Survey of Current Business, Washington, D.C.: U.S. Government Printing Office, 1973–2002.
Zahid, Khan. “Government Budget Deficits and Interest Rates: the Evidence Since 1971, Using Alternative Deficit Measures,”Southern Economic Journal, 54, 1988, pp. 725–31.
Author information
Authors and Affiliations
Additional information
The author is indebted to P. A. V. B. Swamy for ideas and helpful suggestions and Will Perry for data assembly and processing.
Rights and permissions
About this article
Cite this article
Cebula, R. Budget deficits and real interest rates: Updated empirical evidence on causality. Atlantic Economic Journal 31, 255–265 (2003). https://doi.org/10.1007/BF02298819
Issue Date:
DOI: https://doi.org/10.1007/BF02298819