Long-term interest rates and expected future budget deficits: evidence from the term structure

Abstract

This article examines the relationship between current and expected future real Treasury bond yields, forecasts of budget deficits and market risk. Both expected future deficits and risk strongly influenced expected future real Treasury bond yields in the United States in the 1983–2005 period.

Notes

¹ In a survey of published papers, Gale and Orszag (2003) report that of 59 papers reviewed, 29 found a predominantly significant effect of deficits on interest rates, 19 found a predominantly insignificant effect, and 11 found a mixed effect. Of the 10 papers that employed vector auto-regressions, only two found that deficits had a significant effect on interest rates. Of the 18 papers that employed either forward-looking forecasts of future deficits or the unanticipated component of current deficits, 13 reported a significant effect for deficits.