Structural Federal Deficits and Interest Rates: Some Causality and Co-Integration Tests

Abstract

The relationship between federal budget deficits and interest rates has been focus of extensive research. Recently, Cebula [4] examined this relationship empirically and concluded that the federal budget deficit does in fact exercise a positive and significant impact upon nominal Moody's Aaa-rated corporate bond rate [4, 208]. Such a finding is at odds with great majority of recent empirical studies in this area.' If valid, this finding assigns to large deficits significant adverse effects on both private investment (crowding-out), and on trade balance (via an overvalued dollar). Given these profound public policy implications, Cebula's finding warrants further examination.

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