Fiscal Policy and Interest Rates: How Sustainable is the "new Economy"?, Issues 2006-2112
International Monetary Fund, Fiscal Affairs Department, May 1, 2006 - Fiscal policy - 34 pages
This paper explores the determinants of long-term government bond yields in the Group of Seven (G-7) economies and analyzes the factors that could explain the conundrum of very low rates in the face of a variety of adverse factors in recent years. In particular, the paper focuses on the deteriorating fiscal position in the G-7 economies and enquires which factors could have offset their impact on long-term interest rates, and how sustainable they are likely to be. A model of interest rate determination is elaborated and estimated for the G-7, with explicit emphasis on capital flows and public savings. The results suggest a high likelihood of a substantial impact of the weaker budgetary positions in the G-7 on global interest rates when the offsetting unprecedented capital flows slow down.
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Adjusted R2 Alternative Fiscal Indicators assets basis points Bold coefficients budgetary capital mobility coefficients are significant column Cross-section fixed Cross-section weights deficits on interest domestic interest rate empirical expected return expected sign federal funds rate FGLS Figure fiscal deficits fiscal imbalances fiscal policy fixed effects foreign inflows Foreign Official Holdings G-7 average G-7 countries G-7 economies Gale and Orszag global interest rates government bond yield government deficits Hauner hypothesis impact of fiscal increase industrial countries inflation expectations interest rate determination interest-increasing investment motive investment-related large open economies long-term inflation long-term interest rates model of interest money supply null hypothesis Number of obs Panel Regressions parameter percent level percent of GDP percentage points Period weights real interest rates reserve accumulation return on capital savings significant at least statistics Table U.S. treasury unit root Wald test Wald x2 stat Yes No Period Yes Trend Yes Yes Yes