The differing effects of pre-and post-1981 federal budget deficits on tax-adjusted real interest rates

Many economists believe that federal government's budget deficits result in higher interest rates. This increase in interest rates can stifle private investment and impede the real rate of economic growth for the economy. This paper examines the potential impact of federal budget deficits on long-term interest rates for corporate bonds. The study is based on post-war annual US data, and employs a standard demand-supply model. The empirical results in our study provide evidence that the increasing budget deficits lead to higher interest rate for corporate bonds. In this regard, our study supports arguments for the crowding out theory.

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The Tendency Towards Secondarity in Managing Global Imbalances

Annals of the Alexandru Ioan Cuza University - Economics ◽

10.1515/aicue-2015-0020 ◽

2015 ◽

Vol 62 (3) ◽

pp. 291-311

Author(s):

Lucian Croitoru

Keyword(s):

Interest Rates ◽

Free Choice ◽

Developed Countries ◽

Vicious Circle ◽

Budget Deficits ◽

Asian Countries ◽

Real Interest Rates ◽

The Us ◽

The Eu

Abstract In this study, we analyse the factors that have led to the fall of real interest rates on the long term. We show that this tendency, i.e. the fall in real interest rates, which began three decades ago in developed countries is well explained by the emergence and growth of the global saving glut. We formulate the hypothesis according to which the increase in the global excess saving is mostly the result of a process whereby countries place themselves on a secondary position vis-à-vis the US (i.e. secondarity) with regard to taking and managing risks which occur after a crisis. The ensuing peculiarity of global excess saving is that it is generated in an increasing number of countries or economic areas, with the overwhelming part located in a few of them, while the overwhelming part of the global deficit of savings is located in the US. Secondarity is caused both by governments, which have sought to move to excess saving, as was the case of Asian countries (Bernanke, 2005), or to capping budget deficits, as it happened in the Eurozone and in the EU, and by the free choice of every economic agent in the private sector. Secondarity represents a major cause for a vicious circle in which the decline in interest rates to ever lower levels has led to the emergence of financial bubbles, whose bursting requires the further reduction of interest rates, thus generating new bubbles and so on and so forth. Misinterpreted in real time as the “Great Moderation”, this vicious circle went unobserved.

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Federal Budget Policy with an Aging Population and Persistently Low Interest Rates

The Journal of Economic Perspectives ◽

10.1257/jep.31.3.175 ◽

2017 ◽

Vol 31 (3) ◽

pp. 175-194 ◽

Cited By ~ 14

Author(s):

Douglas W. Elmendorf ◽

Louise M. Sheiner

Keyword(s):

Interest Rates ◽

Federal Budget ◽

Federal Spending ◽

Budget Deficits ◽

The Us ◽

Us Government ◽

Low Interest Rates ◽

Budget Policy ◽

Federal Debt ◽

The Government

Some observers have argued that the projections for high and rising debt pose a grave threat to the country's economic future and give the government has less fiscal space to respond to recessions or other unexpected developments, so they urge significant changes in tax or spending policies to reduce federal borrowing. In stark contrast, others have noted that interest rates on long-term federal debt are extremely low and have argued that such persistently low interest rates justify additional federal borrowing and investment, at least for the short and medium term. We analyze this controversy focusing on two main issues: the aging of the US population and interest rates on US government debt. It is generally understood that these factors play an important role in the projected path of the US debt-to-GDP ratio. What is less recognized is that these changes also have implications for the appropriate level of US debt. We argue that many—though not all— of the factors that may be contributing to the historically low level of interest rates imply that both federal debt and federal investment should be substantially larger than they would be otherwise. In conclusion, although significant policy changes to reduce federal budget deficits ultimately will be needed, they do not have to be implemented right away. Instead, the focus of federal budget policy over the coming decade should be to increase federal investment while enacting changes in federal spending and taxes that will reduce deficits gradually over time.

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