NCPA - National Center for Policy Analysis

Budget Deficits and Interest Rates

October 22, 2001

The economic stimulus package recently reported by the House Ways and Means Committee will have little impact on interest rates, says Bruce Bartlett.

Lower revenues from tax cuts may lower the budget surplus or push it into deficit, but the record shows little linkage between budget deficits and interest rates:

  • In 1982, the federal government ran a budget deficit of 4.1 percent of the gross domestic product, and the Treasury's 30-year bond rate averaged 12.8 percent (see figure).
  • In 1993, the government ran a deficit of exactly the same size, as a share of GDP, but the interest rate was just 6.6 percent.
  • Between 1986 and 1987, the deficit fell from 4.3 percent of GDP to 3.1 percent, yet the 30-year bond interest rate rose from 7.8 percent to 8.6 percent.
  • Conversely, between 1991 and 1992, the deficit increased from 3.6 percent of GDP to 4.7 percent, but the interest rate fell from 8.1 percent to 7.7 percent.
  • Between 1995 and 2000, the budget went from a deficit of 2.6 percent of GDP to a surplus of 2.2 percent -- a net change of 4.8 percent of GDP -- equal to over $500 billion.
  • Yet the 30-year bond only fell from 6.9 percent to 5.9 percent over this period.

If the same order of magnitude holds, then a $75 billion loss in revenue -- equal to about 0.7 percent of GDP -- would only raise interest rates by at most 15 basis points (0.15 percent).

The latest research, by economists Douglas Elmendorf of the Federal Reserve and Gregory Mankiw of Harvard University, suggests that the stimulus package being considered by Congress would raise long-term interest rates by at most 5 basis points.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, October 22, 2001.

For Elmendorf-Mankiw study


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