Economic Research Institute Study paper
Utah State University
Increasing federal government deficits have revived interest in theoretical discussions of the deficits' impact on an economy. This theoretical interest has recently been transformed into an economic policy issue in the form of the Gramm-Rudman-Hollings balanced budget legislation. Within the theoretical framework, the question of effects of increasing deficits on interest rates, and thereby on the level of investment and of economic growth is of special interest. Some economists emphasize the negative impact of deficit financing on private investment. This negative impact is largely due to the "fiscal crowd-out" whereby private investment is crowded-out by public borrowing. According to this theory, the public sector issued debt competes with the private sector demand for savings. As a result, interest rates are bid up and the crowding out of private investment occurs. Consequently, the issue of effects of deficits on interest rates is of crucial importance.
Saunders, Peter J., "Deficits and Interests Rates: An Empirical Investigation" (1987). Economic Research Institute Study Papers. Paper 456.