Economics effects of public sector deficits

11 ABSTRACT ECONOMIC EFFECTS OF PUBLIC SECTOR DEFICITS Oya Eylem KANDEMİR Master's Thesis, Department of Public Finance Advisor: Assoc. Prof. Dr. Z. Refia YDLDIRIM September 2004, 135 Page Public sector deficits have been regarded as one of the major economic issues since the second half of the 1970s. Therefore the definition of financing and economic effects of public sector deficits have become a major problem in the evaluation of public finance policies. However there is no concensus among economists concerning the impact of deficits on macro economic outcomes. Keynesian economists assert that public sector deficits help economic activities to expand further. Financing the deficits by debt increases interest rates and decreases private investments. However, some Keynesian economists believe that rising interest rates would not crowd out private investments. According t o Neoclassical economists public sector deficits increase the interest rates and crowd out private investments. In the 1970s the argument concerning the impact of deficits on the economy took a different turn due to the Ricardian assertian that deficits would have no real effects on macro economic policy outcomes. Ricardian equivalence approach claims that public sector deficits would effect neither total demand for goods and services nor interest rates. In this study the relationship between public sector deficits and interest rates were examined by using data for the period of 1987:1-2003:12 in Turkey. The results of the analysis point out that the public sector deficits lead to increases in the interest rates. This finding supports the assertian that there is no base to accept Ricardian equivalaence theorem. Keywords: Ricardian Equivalence theorem, domestic borrowing, public sector deficits, intrest rates, aggregate demand