Does budget deficit affect short and long term interest rates differently?

Abstract

This study examined the differential impact of budget deficit on short and long term interest rates in Nigeria for the period 1970 to 2011. Specifically, this study addressed three issues: the causal nexus between budget deficit and interest rates; the effect of budget deficit on interest rates and the response of interest rates to shocks on budget deficit. Three models were estimated. Firstly, the causality estimate showed no evidence of causation between budget deficit and interest rates. Secondly, the regression estimate revealed that budget deficit had an insignificant effect on interest rates and thirdly, the impulse response analysis showed that shocks to budget deficit causes an immediate positive rise in long term interest rate while the positive response of the short term interest rates was delayed till the sixth year. Thus, this study concluded that, the question of whether budget deficit affects short and long term interest rates differently depends on methodology adopted.