Fiscal Budget Deficit on Interest Rates

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FiscalBudget Deficit on Interest Rates

FiscalBudget Deficit on Interest Rates

Therehas been a lot of debates on interest rates, especially amongfinancial specialists. In a scenario where money is used, the ratewhich is charged for the used money is referred to as the interestrate. The interest rate may be categorized as either real or nominal.The effect of inflation is included under the nominal rate whileinflation is excluded in the actual rate of interest. Factors foundto have an impact on the interest rate can be categorized into fourgroups. These include budget deficit/surplus, policies initiated bythe Federal Reserve, international trade deficit/surplus and businesslevel activity.

Insituations where the expenditure of the federal government is higherthan the revenue obtained from tax, there would be a deficit whichmust be concealed through printing or borrowing money. Borrowing ofmoney by the government would further push the interest rate higher.The possibility of inflation is increased particularly when thegovernment prints money. This contributes to the rise in the interestrates.

Recessionhas a direct impact on consumer demand. Inflation is drasticallyreduced when the consumer demand is low. This partly contributed tothe decrease in prices of various commodities. The wage increase isalso reduced as a result of companies not hiring workers. Thepurchasing power of consumers is reduced as a consequence of a lowdisposable income. This contributes to the minimal investmentswitnessed in companies hence, there is a reduced need for funds.This leads to the decrease in the interest and inflation rate. In abid to increase the possibility of the banks to provide low-interestloans during a recession, the Federal Reserve would buy Treasurybonds under the custody of the banks. This purchase would cause theinterest rate to decrease while driving the bond prices (Laubach,2009). The interest rate follows a fluctuating phenomenon where ittends to be higher when the business is at its peak and low during arecession.

Theexchange rate in the United States is influenced by the rise in theinterest rate. This is as a result of the impact caused on theforeign exchange market due to the influence on the demand and supplyof currencies. A relative increase in the interest rate as comparedto that in the United Kingdom, the transfer of funds from sterlingpounds securities to dollar dominated securities would be an addedadvantage. This would affect the price of the dollar resulting in anappreciation of the dollar. A buyer from the UK would have to give upmore pounds when purchasing the same amount of dollars hence theimport price would rise. The value of the dollar will increase ascompared to the currencies of other countries due to the upsurge inthe interest rate. With all other aspects being constant, there wouldbe increased export prices and decreased import prices due to anappreciation of the interest rate (Evans, 1987).

TheUS economy and the rest of the world is purposely driven by theeffects of the interest rates. In countries where interest ratecontrol is considered mandatory by the governments, rapid developmentwould be witnessed. This is the case for China and India. Interestrates must be strictly monitored if a country wants early developmentand the growth of its people. Such countries should also embracedetailed analysis of economic factors in comparison to theinternational factors. This should be done regularly (Alesina andTabellini, 1990).

Inconclusion, there is still debate about the amount of deficitrequired to have an effect on the interest rate. Interest ratereduction requires a balanced budget. There is also an impendingreduction in the commercial and retail borrowing due to high-interestrates especially in the private sector the private sector.


Alesina,A., &amp Tabellini, G. (1990). A positive theory of fiscal deficitsand government debt. TheReview of Economic Studies,57(3),403-414.

Evans,P. (1987). Interest rates and expected future budget deficits in theUnited States. Journalof political Economy,95(1),34-58.

Laubach,T. (2009). New evidence on the interest rate effects of budgetdeficits and debt. Journalof the European Economic Association,7(4),858-885.