Determinants of Long-Term Real Interest Rate Yields: The Case of the US

Corporate management must be keenly aware of the factors that influence the long-term interest rates since it affects a host of profit-influencing and growth-influencing dimensions of strategy and operations, ranging from investment in capital decisions to financial investment of retained earnings, expected sales revenue, hiring, and outsourcing. To provide an insight into the determinants of long-term interest rate yields, this study investigates the impact of the federal budget deficit and other factors on the ex post real interest rate yield on long-term bonds in the US. To measure the budget deficit, the study adopts primary budget deficit, which excludes net interest payments by the Treasury. Error correction model estimations reveal a possible bidirectional relationship between primary deficit and the ex post real interest rate yield on high grade tax-free municipal bonds, i.e., the primary deficit appears to positively cause the real yield on long-term tax-free issues and vice versa. Another insight into interest rate determination that is provided, is the positive and significant impact of short-term interest rates on long-term rates.