Budget Deficits and Long-Term Interest Rates in Japan

The effect of budget deficits on the economy is one of the most important unresolved issues in public economics and macroeconomics. Based on a simple loanable funds model that describes the relationship between budget deficits and long-term interest rates, this study empirically quantifies how Japan’s large budget deficits affects long-term interest rates and the slope of the yield curve in Japan. Estimation based on the quarterly data for the period 1981.II-2009.I reveals statistically significant evidence of the positive link between budget deficits and long-term interest rates. This finding supports the Keynesian view of the budget deficit and is generally consistent with the recent studies that employed improved and expanded dataset in the United States.