International Capital Inflows, Federal Budget Deficits, and Interest Rates, 1971—1984

This study investigates the impact of federal budget deficits on both short-and longterm interest rates from 1971 to 1984 within an open IS-LM model that includes net international capital inflows. Two time periods are examined using quarterly data: 1971.4 to 1984.4 and 1979.4 to 1984.4. Short-term rates are unaffected by the federal budget deficit in both periods. Long-term rates are an increasing function of the deficit over the 1971.4 to 1984.4 period, but are relatively unaffected by budget deficits during the 1979.4 to 1984.4 period. The evidence implies that net international capital inflows over the latter period offset the interest rate effects of the federal deficit.