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Federal budget update

October budget data released today show a modest improvement in federal government finances, thanks mainly to the fact that spending in October of this year was about $90 billion less than it was in October of last year, when the frenetic bailouts and TARP legislation were launched. Still, spending growth is likely to continue to outpace revenue growth, with the result that the federal debt will continue to rise in relation to the economy. As this next chart shows, there does not appear to be any solid relationship between debt outstanding and long-term Treasury yields. Indeed, the relationship appears for the most part to be counter intuitive, with bond yields moving inversely to the size of the debt. Within reasonable limits (which we are still within), there is no reason for large deficits to impact interest rates, mainly because the latter are driven by inflation. Inflation, in turn, is ultimately controlled by the Fed, whose purchases this past year of $1 trillion or so of Treasuries and MBS threatens to push inflation higher in coming years.

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