Long-Term Interest Rates: The Role of Expected Budget Deficits

Abstract

A relatively simple loanable funds model is utilized to explain the 10-year government bond yield during 1970–86. In the reduced form equation, expected inflation, expected structural deficits as a percentage of GNP, output growth, and liquidity growth appear as exogenous variables. Using alternative measures of expected inflation and expected deficits, the regression results indicate a powerful effect of expected deficits on the 10-year government bond yield. The increase in expected deficits raised bond yields by some 180 basis points by early 1984, and the anticipation of deficit-reduction legislation accounts for about one-third of the decline in yields during 1985–86, according to the model. In alternative experiments, tests are conducted to see whether bond yields “Granger-cause” forthcoming deficits. Our findings are consistent with the view that agents are forward-looking and foresee the direction of major changes in structural deficits.

Determinants of the Government Bond Yield in Spain: A Loanable Funds Model

“…The literature suggests that more government deficit/debt may or may not lead to a higher interest rate. Feldstein [1], Hoelscher [2], Wachtel and Young [3], Zahid [4], Thomas and Abderrezak [5], Miller and Russek [6], Raynold [7], Cebula [8], Vamvoukas [9], Ewing and Yanochik [10], and Saleh and Harvie [11] maintained that there is a positive relationship between the government deficit/debt and the interest rate. However, Kormendi [12], Hoelscher [13], Aschauer [14], Makin [15], McMillin [16], Evans [17][18][19], Gupta [20], Darrat [21,22], Findlay [23], and Ostrosky [24] indicated that more government deficit/debt would not lead to a higher interest rate.…”

“…The loanable funds model has been employed in studying the impact of government deficits or debt on interest rates (Hoelscher [13], Tran and Sawhney [28], Thomas and Abderrezak [5], Cebula [8,29], Correia-Nunes and Stemitsiotis [30], García and Ramajo [31], Barnes [32], Hoelscher [13] developed a closed-economy loanable funds model, and Cebula [8,29] proposed an open-economy loanable funds model by considering the net capital inflow in the supply of loanable funds.…”

National Debt and Its Effects on Several Other Variables: An Econometric Study of the United States

“…Dornbusch and Frankel (1987) argued that a shortfall in national saving, even if capital is mobile, could still drive real interest rates above world levels and crowd out domestic investments. Thomas and Abderrezak (1988) found that long-term bond yields are highly sensitive to the magnitude of expected budget deficits. Bowies, Ulbrich, and Wallace (1988) briefly outlined a theory that expansionary monetary or fiscal policy can lower the interest differentials between risky and default riskless bonds, thus reducing the crowding out effects on private spending.…”

The Government Debt and the Long-Term Interest Rate: Application of the Loanable Funds Model to Greece

“…The loanable funds model has been employed in studying the impact of the government deficit or debt on interest rates (Hoelscher, 1986;Tran and Sawhney, 1988;Thomas and Abderrezak, 1988;Cebula, 1988Cebula, , 1994Cebula, , 1997aCebula, , 1997bCebula, , 1998Cebula, , 1999Cebula, , 2000Cebula, , 2003Cebula, , 2005Correia-Nunes and Stemitsiotis, 1995;García and Ramajo, 2004;Quayes and Jamal, 2007;Barnes, 2008). Hoelscher (1986) develops a closed-economy loanable funds model, and Cebula (1988Cebula ( , 1994Cebula ( , 1997aCebula ( , 1997bCebula ( , 1998Cebula ( , 1999Cebula ( , 2000Cebula ( , 2003 proposes an open-economy loanable funds model by considering the net capital inflow in the supply of loanable funds.…”