Do Budget Deficits Matter: Evidence From Turkey

Feride Ozturk-Degirmen

Carow Hall, Library
April 25, 2004, 08:00 PM to 07:00 PM


The dissertation presents evidence on whether, and by what degree, government budget deficits raise interest rates in Turkey, where unprecedented increases in budget deficits have prevailed since the late 1980s. The increasing size of budget deficits and the financing of these deficits through government securities has been of primary concern for policy makers. Though there is much concern over running budget deficits, the association between budget deficits and interest rates is not obvious in either economic theory or empirical evidence. This dissertation presents three alternate theories: the Keynesian crowding-out hypothesis, the Ricardian Equivalence proposition, and the monetization view that relates budget deficits to interest rates. Both a Vector Autoregression (VAR) and event study methodologies are employed to test whether budget deficits affect interest rates in Turkey, and if so, whether the direction and magnitude of interest rate changes are consistent with the predictions of the above-mentioned theories. Evidence from VARs showed that budget deficits increased real interest rates and hence crowded-out private investment spending. The appreciation of the lira in response to increased deficits indicates that some of the crowding-out effect was transferred from investment to the export sector. Evidence from an event study confirmed these findings. In addition, this study supports the new IMP-backed Strengthened Stabilization Program, which was adopted in May 2001. This program strictly recommended tight fiscal policy and careful debt management aimed at long-term sustainability in Turkey. It seems that reducing budget deficits will not only stimulate investment spending but also help to reach external balance by lowering the trade deficit.