DOMESTIC AND INTERNATIONAL FINANCIAL MARKET RESPONSES TO FEDERAL DEFICIT ANNOUNCEMENTS

This study examines the response of domestic and international financi al variables to announced changes in Federal deficit projections over the 1981-94 period. As observed in earlier studies, rates on US Treasu ry securities responded positively to announced increases in Federal d eficit projections. New evidence shows that deficit effects are transm itted internationally with foreign long-term interest rates also incre asing in response to announced increases in US deficit projections. Th e exchange value of the dollar tends to be positively related to annou nced changes in deficit projections, but that result appears to be rel ated to the degree of insulation of foreign financial markets from US financial markets. Finally, the price of gold responded positively to announced changes in deficit projections. Taken together the results s uggest that higher projected deficits raise real interest rates in par t because of an increase in an inflation risk premium.