Budget Deficits and Interest Rates: An Empirical Analysis for Turkey

Abstract

The aim of this study is to analyze causality between budget deficits and its ratio to gross domestic product and interest rate in the Turkish economy during years between 2006 and 2011. By doing so, we investigate the validity of crowding out view against the Ricardian equivalence hypothesis. To this end, we employee the conventional Toda-Yamamoto (1995) linear Granger type causality test and Hacker and Hatemi-J (2005, 2006) bootstrap process-based Toda-Yamamoto linear Granger type causality test. In this regard, we use Kwiatkowski, Phillips, Schmidt and Shin (1992, KPSS) and Elliot, Rothenberg, Stock (1996, DF-GLS) unit root tests. Analysis results show that there is no causal relation between budget deficits, budget deficit ratio to gross domestic product and nominal interest rate. Results reveal the existence of Ricardian equivalence hypothesis. Rational household predict that there is no difference between payment time of taxes and they know that expansionary fiscal policies financed by loan do not affect aggregate demand and capital allocation in a full-employment economy via nominal interest rate channel. Results of empirical analysis support Ricardian equivalence hypothesis and imply that there is no effect of financing type of budget deficit on nominal interest rate.

Keywords

• Ricardian Equivalence
• Crowding-out
• Budget Deficit
• Bootstrapped Causality Analysis
• Turkish Economy