Do Government Spending Shocks Increase Interest Rates?

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Economics | Social and Behavioral Sciences


John Olson, Economics


A major debate in the field of economics in the 1980s was related to the topic of budget deficits and what affects they had on the macro-economy. The topic was heavily researched and the empirical results were mixed. Using annual data on the U.S. for the 1951 to 2001 time period, OLS regression analysis was used to test the affect real government total expenditure shocks have on both short and long-term nominal interest rates. The results indicate a statistically significant positive relationship between real government total expenditure and all of the interest rates tested for the fifty year time period. However, since 1978 the U.S. has been running huge current account deficits which are helping to finance the large amounts of government spending. As a result, the data indicates that desired national saving is not decreasing with the government spending shocks and therefore there is no upward pressure on interest rates. Instead, the U.S. government is acquiring a growing external debt, which means a continuing shift in net income received from abroad in favor of foreigners.