Interest rates

What effect will government spending have on interest rates? So far, most of the story has been about whether interest rates will be lower under Labor or the Coalition (to read my view on that debate, click here). But another issue is whether over-spending in a boom could lead to higher deficits the next time the economy turns south. With both parties looking at the election war chest like Takeru Kobayashi eyeing a plate of hot dogs, it’s worth asking the question: how much does government spending affect interest rates?

According to a new paper by Eric M. Engen and Glenn Hubbard (formerly the head of Bush’s Council of Economic Advisers), if the deficit rises by 1% of GDP (about $7 billion, in Australia’s case), long-term real interest rates will increase by about 3 basis points. That’s higher than previous papers have found, and a result which is worth bearing in mind, given the amount of money potentially being thrown around in the next four weeks.

Note: Unless you’re at a university, you’ll have to pay to download the full version of the Engen and Hubbard paper. Sorry – I couldn’t find a free version to link to.

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