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The Economics of Fiscal Defecits

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It's quite difficult if not virtually impossible to have forecasting abilities to consistently predict future economic scenarios. Even if a prediction about what will happen to our economy is done accurately, an investor is not done yet. In order to capitalize upon an accurate economic prediction, the investor must still translate the economic prediction into a successful investment strategy and must also get the timing of it correct. No small feat indeed.

As we get through a political season where much in relation to our country's economics have been discussed or at least used in the negative political ads that seemingly permanently reside on my television, it's helpful to keep things in perspective and look at things objectively. Marlena Lee, Researcher with Dimensional Fund Advisors, examines historical data to test the relationships between fiscal deficits, interest rates, business activity, investment returns, and exchange rates in a video and/or podcast available by clicking the link below.

http://www.dfaus.com/2010/11/the-economics-of-fiscal-deficits.html

To summarize her findings, Marlena academically tested the following economic questions and their potential investment implications. The short answer to the question is shown bolded in ALL CAPS.

Economic Questions:


• Are deficits related to higher long-term interest rates? YES

• Do large deficits stifle long-run economic growth? YES

• Are fiscal deficits linked to current account deficits? INCONCLUSIVE

Investment Implications:

• Do interest rates efficiently incorporate information about fiscal policy? YES

• Do deficits predict bond or equity returns? NO

• Does low future economic growth imply low future equity returns? NO

• Do fiscal deficits and/or current account deficits predict short-term exchange rate movements? NO

Remember, in our era of the in-your-face, usually negative media, it's important to stay objective. The sky may not be falling after all.

Kevin Kroskey, CFP, MBA
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