How does government spending news affect interest rates? Evidence from the United States

Yong Chen () and Dingming Liu ()

Journal of Economic Dynamics and Control, 2019, vol. 108, issue C

Abstract: This study analyzes the effects of news shocks to U.S. government spending on interest rates, especially long-term interest rates, and investigates the role of agents’ expectations in the propagation of government spending to interest rates. Using large Bayesian vector autoregressive models with sufficient information, we find that news about increases in government spending induce significant increases in both short- and long-term interest rates while the effects of government spending surprise shocks on interest rates are mixed and ambiguous. Government spending news shocks in the baseline model account for around 10% of the variance in forecast errors in long-term interest rates, which is much more important than government spending itself. Using empirical dynamic term structural models, we further decompose increases in long-term interest rates into changes in expectations of future monetary policy and changes in term premiums. We find that an increase in the long-term interest rate after a positive government spending news shock mainly reflects higher expected future short-term interest rates, which demonstrates the importance of the coordination between fiscal and monetary policy communication.

Keywords: Government spending; News shocks; Large Bayesian vector autoregression; Term structure models (search for similar items in EconPapers)
JEL-codes: C11 E43 E62 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:108:y:2019:i:c:s0165188919301460

DOI: 10.1016/j.jedc.2019.103747

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