The Fiscal Impact of Government Budget Deficits on Macroeconomic Variables: A FAVAR Approach

Document Type : Original Article

Authors

1 PhD in Economics, University of Tehran, Iran

2 Associate Professor at Mofid University

3 Assistant Professor, Institute of Business Studies

10.22091/ise.2025.12505.1013

Abstract

This paper examines the impact of government deficit financing shocks, specifically through the channels of money printing and government securities issuance, on macroeconomic variables. Using data from 1991 to 2023, we employ a Factor-Augmented Vector AutoRegression (FAVAR) model to assess the effects of these shocks. The sources of the government budget deficit are financed through three ways: external borrowing, domestic borrowing (issuing bonds), and borrowing from the banking system. If the budget deficit is financed through external sources, it may lead to a current account deficit and even a foreign debt crisis. If it is financed through domestic borrowing (issuing bonds), it will cause an increase in interest rates, which will lead to a decrease in private sector investment and economic growth. Finally, if the budget deficit is financed through borrowing from the banking system, this may have adverse economic effects due to increased liquidity and subsequent increase in aggregate demand. Our results indicate that securities-financed deficits lead to more persistent inflationary pressures compared to money-financed deficits. Both methods resulted in a short-term increase in production; however, in the medium and long term, they exhibited negative effects.

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