Interest rates and budget deficits revisited-evidence from the G7 countries

This article revisits whether budget deficits affect interest rates, and broadens the literature by examining whether financial globalization has changed this relationship. A structural model of interest determination is extended to account for the fact that official capital flows are determined differently than private flows and is estimated for a 1960-2005 G7 panel. We find that deficits have a significant but small effect on long-term rates, but that this result depends on the fiscal concept used. Moreover, we find no evidence of structural change in interest rate determination in the recent decades, with the exception of an increased impact of insurance-related capital inflows in recent years.