Deficit Announcements and Interest Rates.

In an efficient market, information about any determinant of interest rates should be quickly incorporated into observed rates. Thus, when information about the size of the deficits is released, a relatively quick impact on interest rates can be anticipated. More specifically, if an increase in the deficit is, in fact, associated with higher interest rates, then an unanticipated announcement of a larger deficit should lead to a response in financial markets, which increases interest rates. This paper provides evidence on the announcement effects of information on the deficit. The macroeconomic hypothesis underlying this investigation is simply that an increase in the current or future deficit leads to an increase in yields on government securities in anticipation of higher levels of debt financing. In a rational expectations framework, an announcement of higher future deficits will lead to a current increase in interest rates in anticipation of future financing. Thus, the examination of announcement effects enables us to substantiate a relationship between interest rates and deficits without encountering the econometric problems of reduced form modeling.