Government Deficits and Interest Rates: A Keynesian View

Brett Palatiello () and Philip Pilkington ()
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Brett Palatiello: Ridgewood Analytica
Philip Pilkington: Savenay Advisers

No inetwp183, Working Papers Series from Institute for New Economic Thinking

Abstract: We test the neoclassical loanable funds model which postulates that, ceteris paribus, government borrowing increases the long-term rate of interest. The empirical literature exploring such a connection remains largely mixed. We clarify the conflicting results by deploying an ARDL model to decompose the relationship in the United States into long and short-run effects across multiple measures of the government deficit and long-term interest rate. We find a tendency for changes in the deficit to increase long-term interest rates in the short run but the effect is reversed in the long run. We argue that these results are consistent with John Maynard Keynes’ view of the long-term rate as being heavily influenced by monetary policy, central bank credibility and market convention.

Keywords: budget deficits; interest rates; crowding out; central bank; monetary policy; Keynes (search for similar items in EconPapers)
JEL-codes: E43 E50 E58 E60 G10 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2022-04-09
New Economics Papers: this item is included in nep-cba, nep-mon and nep-pke
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https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4138668 First version, 2022 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:thk:wpaper:inetwp183

DOI: 10.36687/inetwp183

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