BUDGET DEFICITS AND INTEREST RATES: THE US EVIDENCE SINCE 1946

Abstract

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.