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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page The Effect of Deficit-Reduction Laws on Real Interest Rates
Douglas W. Elmendorf

Abstract: This paper uses news reports about two deficit-reduction laws of the past decade to identify days when expected fiscal policy clearly became more or less expansionary. The paper also proposes a technique for identifying whether the real interest rate increased or decreased on those days, based on changes in the nominal interest rate, the exchange rate, commodity prices, and stock prices. As economic theory predicts, higher expected government spending and budget deficits raised real interest rates and the value of the dollar, while lower expected spending and deficits reduced real rates and the value of the dollar.

Keywords: Interest rates, budget deficit, government spending

Full paper (203 KB PDF) | Full paper (320 KB Postscript)

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Last update: July 16, 1997