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Government Deficits And Long Term Interest Rates Notes

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Candidate Number 2864B

Economics Tripos Part IIA Paper 3 Take Home Examination Question 1: "Do large government deficits raise long-term interest rates?
Assess using time-series data on one country."

Contents

1. Introduction

2. Theory

3. Literature review

4. The model

5. Data

6. Estimation

7. Conclusion

8. Appendix

Word Count: 1993 (Excluding footnotes and Appendix)

1|Page

1. Introduction The relationship between government deficits and long-term interest rates is a topic of frequent debate. The two graphs below show the development of 10 Year US Treasury Note Yields and the US federal deficit as share of GDP over the last 55 Years.

At first sight, it looks as if there is a weak inverse relationship between the two series, so that higher deficits are correlated with higher interest rates. Using time series data on the United States, I will estimate a vector autoregressive model (VAR) to see whether large government deficits actually raise long-term interest rates.

2|Page

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