Government Deficits and Interest Rates: A No-Arbitrage Structural VAR Approach
28 Pages Posted: 2 Jan 2005
Date Written: March 14, 2004
What is the effect of government deficits on interest rates? This fundamental question has not been convincingly answered. We propose a no-arbitrage structural VAR method that allows us to incorporate the cross-sectional information in bond yields into a structural macroeconomic framework. We find that the government deficit is an important factor behind the yield curve: A one percentage point increase in the deficit increases the 10 year rate by 41 basis points.
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