The Government Deficit and the Long-Term Interest Rate: Application of an Extended Loanable Funds Model to Sweden

  •  Yu Hsing    


Applying and extending the open-economy loanable funds model, this paper finds that more government deficit as a percent of GDP leads to a higher government bond yield and that a higher real Treasury bill rate, a smaller percent change in real GDP, a higher expected inflation rate, a higher U.S. government bond yield, or depreciation of the Swedish krona (SEK) against the euro would increase the Swedish government bond yield. When the standard closed-economy or open-economy loanable funds model is considered, we find similar conclusions for the ratio of the government deficit to GDP, the real Treasury bill rate, and the expected inflation rate whereas the negative coefficient of the percent change in real GDP or the ratio of the net capital inflow to GDP is insignificant at the 10% level. Hence, the incorporation of the world long-term interest rate and the exchange rate would better capture the behavior of the Swedish government bond yield.

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