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 , public debt , long-term interest rates

JEL(s): E44 , E62 , H62

Programme Areas: International Macroeconomics , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP4661.asp

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.