1.1. Keynesian theory predicts that expansionary fiscal policy—

either higher spending or lower taxes—will raise the real interest rate.

Using data since 1960, graph the Federal government budget deficit, the state-local government budget deficit (both relative to GDP), and the real interest rate (three-month Treasury bill rate minus the CPI inflation rate over the preceding twelve-month period). Do you see a link between deficits and real interest rates?

In what period does the relationship seem clearest? Do your answers change when the ten-year government bond interest rate is used instead of the three-month rate?