Economic Report of the President 1994 - The American Presidency ...

Meanwhile, the Mountain States were 1993's growth leaders.Strong income and employment gains were seen in Utah, Colorado,New Mexico, and Arizona (Chart 2-11).DEFICIT REDUCTION ANDTHE REAL INTEREST RATEAs the new Administration took office, it appeared that the ratioof Federal Government debt to GDP was on an unsustainable upwardpath. The explosion of debt in the 1980s had kept real interestrates high throughout the decade. Hence, nominal rates did notfall by as much as the 1980s' victory against inflation warranted.Much of the recent reduction in long-term interest rates, it will beargued below, should be attributed to the change in budget policyin early 1993. The close linkage of the decline in long-term interestrates to the political and legislative events of the last 15 monthsgives strong support to the view that high Federal debt in the1980s was responsible for the high real returns on long-term bonds,and that the change in Federal fiscal policy is responsible in largepart for the declines in real interest rates.The President's economic plan reoriented fiscal policy from consumptiontoward investment, both by reducing the size of projectedbudget deficits and by changing the composition of Federal spendingfrom current expenditures to investment. The reduction in futureFederal borrowing was well received by the financial markets.In the words of the Federal Reserve Board Chairman in his July1993 Humphrey-Hawkins testimony, the financial markets"brought forward" the effects of future deficit reduction. The eventanalysis shown in Chart 2-12, linking the announcement and enactmentof credible budget reduction to changes in the long-terminterest rate, provides support for the view that the interest ratedeclines were largely due to budget policy.Long-term interest rates are near the lowest they have beensince the 1960s. On election day 1992, the 10-year Treasury yieldwas 6.87 percent. It has ratcheted down several times since then,with the declines closely tied to political and legislative events. Theyield fell to 6.02 percent at the end of February, following TreasurySecretary Bentsen's announcement of the proposed energy tax andthe President's speech announcing his economic plan. The declinestalled in April when the stimulus component of the President'splan was filibustered in the Senate. It resumed its downwardmovement when the House passed the President's budget in lateMay. It then fell to 5.51 percent at the end of August after the planwas finally enacted by the Congress.Long-term rates did increase in late 1993, reversing some of thedecline that followed the passage of OBRA93. Reports in the finan-78