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Francesco Caselli

30 November 2004
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. However, domestic fiscal policy continues to affect domestic interest rates even after controlling for worldwide debts and deficits.
JEL Code
E62 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Fiscal Policy
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
H62 : Public Economics→National Budget, Deficit, and Debt→Deficit, Surplus