Large Deficits Produce High Interest Rates

Evans has argued that the federal budget deficit in the United States does not influence the real rate of interest. Indeed, Evans (1985, p. 85) goes so far as to claim that “in over a century of U.S. history, large deficits have never been associated with high interest rate”. By contrast, using two quarterly models that directly parallel Evans’ IS-LM framework, we find strong empirical evidence that the federal budget deficit does in fact raise the ex post real rate of interest. It would appear that Evans’ conclusions are questionable.