Deficit-Financed Tax Cuts and Interest Rates

1. Define the following terms used in the reading:
   1. budget deficit
   2. supply-side economics
   3. national savings
   4. current account
   5. capital account
   6. Ricardian equivalence
   7. real long-term interest rate

2. Historically, under what circumstances did budget deficits arise? When and why did this pattern end?

3. Explain how and why an increase in a country's budget deficit would affect the real long-term interest rate, the level of national saving, the current account, and future economic growth in each of the following situations:
   1. the country cannot borrow from other countries
   2. the country can borrow from other countries
   3. Ricardian equivalence holds

4. Empirical studies suggest there is no clear relationship between current budget deficits and long-term interest rates, but that an increase in expected budget deficits is associated with an increase in long-term interest rates. How were studies concluding the latter result designed and what were their findings?

Source: "Deficit-Financed Tax Cuts and Interest Rates." Sylvain Leduc, Federal Reserve Bank of Philadelphia Business Review, Second Quarter 2004, pp. 30-37.