DP4661 Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries

Author(s): Silvia Ardagna, Francesco Caselli, Timothy Lane
Publication Date: October 2004
Keyword(s): government deficit, long-term interest rates, public debt
JEL(s): E44, E62, H62
Programme Areas: International Macroeconomics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4661

We use a panel of 16 OECD countries over several decades to investigate the effects of government debts and deficits on long-term interest rates. In simple static specifications, a one-percentage-point increase in the primary deficit relative to GDP increases contemporaneous long-term interest rates by about 10 basis points. In a vector autoregression (VAR), the same shock leads to a cumulative increase of almost 150 basis points after 10 years. The effect of debt on interest rates is non-linear: only for countries with above-average levels of debt does an increase in debt affect the interest rate. World fiscal policy is also important: an increase in total OECD-government borrowing increases each country?s interest rates. Domestic fiscal policy continues to affect domestic interest rates, however, even after controlling for worldwide debts and deficits.