Much debate has recently centered on the popular view that large U.S. budget deficits financed by the sale of bonds cause high interest rates. If valid, this view implies that deficits crowd out efficient private investment and adversely affect economic growth. However, Bailey [2] and Barro [3] have challenged this conventional view on theoretical grounds. Based on the Ricardian Equivalence proposition, Bailey and Barro contend that rational economic agents interpret government deficits as postponed tax liabilities and thus will have no effects on private wealth or interest rates. Such theoretical ambiguity in regards to the impact of budget deficits has also been matched by an equally conflicting empirical evidence. For example, Barth, Iden and Russek [4], DeLeeuw and Holloway [8], Hutchison and Pyle [20], Makin [24], Makin and Tanzi [25], and Zahid [35] have found a positive and significant effect of deficits on interest rates. On the other hand, Evans [11; 12; 13], Hoelscher [17], Motley [28], and Plosser [29; 30] have all failed to find any systematic support for a significant positive impact of deficits on interest rates.' It should be observed that the above empirical studies have employed either monthly or quarterly data. However, some researchers, e.g., Hoelscher [18], have recently charged that monthly or quarterly data bias the results in favor of finding no significant linkage between deficits and interest rates. They reasoned that portfolio adjustment lags are too long for monthly or even quarterly observations to reflect the actual correlation between deficits and interest rates. To eliminate this problem of periodicity, annual data was instead advocated.2 Using annual data, Hoelscher [18] concluded that deficits have caused positive and significant changes in long-term interest rates in the United States.