TY  - JOUR
AU  - Dai,Qiang
AU  - Philippon,Thomas
TI  - Fiscal Policy and the Term Structure of Interest Rates
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 11574
PY  - 2005
Y2  - August 2005
UR  - http://www.nber.org/papers/w11574
L1  - http://www.nber.org/papers/w11574.pdf
N1  - Author contact info:
Qiang Dai
Kenan-Flagler Business School
University of North Carolina
Campus Box #3490
McColl Building
Chapel Hill, NC 27599
Tel: 919/962-7182
E-Mail: qiang_dai@unc.edu

Thomas Philippon
New York University
Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY  10012-1126
Tel: 212/998-0490
Fax: 212/995-4233
E-Mail: tphilipp@stern.nyu.edu
M2  - featured in NBER digest on 2005-08-22
AB  - Macroeconomists want to understand the effects of fiscal policy on interest rates, while financial economists look for the factors that drive the dynamics of the yield curve. To shed light on both issues, we present an empirical macro-finance model that combines a no-arbitrage affine term structure model with a set of structural restrictions that allow us to identify fiscal policy shocks, and trace the effects of these shocks on the prices of bonds of different maturities. Compared to a standard VAR, this approach has the advantage of incorporating the information embedded in a large cross-section of bond prices. Moreover, the pricing equations provide new ways to assess the model's ability to capture risk preferences and expectations. Our results suggest that (i) government deficits affect long term interest rates: a one percentage point increase in the deficit to GDP ratio, lasting for 3 years, will eventually increase the 10-year rate by 40--50 basis points; (ii) this increase is partly due to higher expected spot rates, and partly due to higher risk premia on long term bonds; and (iii) the fiscal policy shocks account for up to 12% of the variance of forecast errors in bond yields.
ER  -