An Empirical Investigation into the Impact of U.S. Federal Government Budget Deficits on the Real Interest Rate Yield on Intermediate-term Treasury Debt Issues, 1972-2012

The existence of large federal budget deficits in the U.S., especially in recent years, raises the specter of concern regarding their potential effects on real interest rates (as well as economic growth and capital formation). This study provides current and new empirical evidence on the impact of the federal budget deficit on the real interest rate yields on intermediate-term debt issues of the U.S. Treasury, represented herein by the ex post real interest rate yields on three-year Treasury notes and seven-year Treasury notes, two interest rate measures that have received essentially no attention in the economics and finance literature in recent years. The study is couched within a loanable funds model that includes two ex post real interest rate yields, the monetary base as a percent of GDP, the change in per capita real GDP, net financial capital inflows as a percent of GDP, and the budget deficit as a percent of GDP. This study uses annual data for the study period 1972-2012, a time period that includes “quantitative easing” monetary policies by the Federal Reserve. Two-stage least squares estimations reveal that the federal budget deficit, expressed as a percent of GDP, has exercised a positive and statistically significant impact on the ex post real interest rate yields on both three-year and seven-year Treasury notes, even after allowing for quantitative easing and other factors. The study also considers the 1980-2012 time period and offers simple robustness testing.