| Higher interest rates have long-run and short-run impacts on the economy, including reduced capital formation and damaging impacts on housing. The problem addressed in this study is whether increasing federal budget deficits/debt put upward pressure on interest rates. Economic theory offers opposing views---a conventional view that rising deficits/debt put upward pressure on interest rates or, alternatively, a Ricardian Equivalence view that they do not. Empirical work in this study assessed the relationship using econometric tools, principally regression methods, and alternative measures of interest rates, alternative measures of the deficit/debt, and alternative time periods for analysis. The underlying data were mainly economic time series measures available from government sources, including the Federal Reserve. The findings of the study were mixed, but provided sufficient evidence that there is a significant relationship between deficits/debt and interest rates. Specifically, interest rates adjusted for inflation and long-term rates versus short-term rates appear particularly sensitive to movements in the deficit/debt in some periods, with debt tending to be slightly more predictive in an array of tests. The interest rates-deficit/debt relationship does not appear to be stable over time; however, in a prior period of sluggish economic performance, which has similarities to today, a significant relationship was found. Given current high deficits and rising debt, the implication of the study for social change is that there is policy urgency to quickly reverse the course of deficits/debt prospectively in order to support capital formation for future economic growth and protect the housing market for consumers. |
