Whither crowding out? : Commonwealth budget deficits, the term structure of interest rates, and the twin deficits hypothesis

Growder, Michael. (1996). Whither crowding out? : Commonwealth budget deficits, the term structure of interest rates, and the twin deficits hypothesis Honours Thesis, School of Economics, University of Queensland.

       
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Author Growder, Michael.
Thesis Title Whither crowding out? : Commonwealth budget deficits, the term structure of interest rates, and the twin deficits hypothesis
School, Centre or Institute School of Economics
Institution University of Queensland
Publication date 1996
Thesis type Honours Thesis
Total pages 104
Language eng
Subjects 14 Economics
Formatted abstract This thesis examines the effect of Commonwealth budget deficits on both the term structure of interest rates and the current account balance in the Australian setting. 'Conventional' theory suggests that in a closed economy, debt-financing ofa deficit causes higher interest rates. This in turn leads to a 'crowding out' of capital accumulation, to the detriment of the economy's longer-term growth prospects. In a small open economy, the expected increase in interest rates resulting from the deficit will lead instead to an appreciating currency, a 'crowding out' of net exports, and a current account deficit. This is the 'Twin Deficits' hypothesis. The 'Ricardian Equivalence Hypothesis', however, posits that budget deficits will instead be neutral in their effects on interest rates, and thus the economy.

The focus of the empirical research in this thesis is to determine the existence and direction of causal relationships between budget deficits, the term structure of interest rates, and the current account in Australia. A variety of econometric techniques were utilised, including tests for cointegration, and tests for Granger-causal relationships in bivariate and multivariate autoregressive (MVAR) frameworks. The tests conducted consistently rejected any support for the conventional reasoning, whether in a closed or an open economy framework.

 
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