An Investigation into the Impact of Federal Government Budget Deficits on the Ex Ante Real Interest Rate Yield on Treasury Notes in the U.S.

Using four decades of data, this empirical study adopts a loanable funds model to investigate the impact of the federal government budget deficit in the U.S. on the ex ante real interest rate yield on ten-year Treasury notes. For the 40-year period 1973-2012, an autoregressive 2SLS estimate finds that the ex ante real interest rate yield on ten-year U.S. Treasury notes was an increasing function of the ex ante real interest rate yield on Moody’s Aaa-rated corporate bonds, the ex ante real interest rate yield on three-month Treasury bills, and the increase in per capita real GDP, while being a decreasing function of net capital inflows (as a percent of GDP), which are treated as endogenous, and the monetary base (as a percent of GDP). In addition, it is found that that the federal budget deficit (relative to the GDP level) exercised a positive and statistically significant impact on the ex ante real interest rate yield on ten-year Treasury notes, a finding consistent in principle with a number of prior studies of other interest rate measures during shorter and earlier time periods. A modest robustness test using the ex ante real seven-year Treasury note yield generates the same conclusions.