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

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  • Ardagna, Silvia
  • Lane, Timothy
  • Caselli, Francesco
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    Abstract

    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.

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    Bibliographic Info

    Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 2579739.

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    Date of creation: 2007
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    Publication status: Published in The B.E. Journal of Macroeconomics
    Handle: RePEc:hrv:faseco:2579739

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    1. Drudi, F. & Prati, A., 1998. "Signaling Fiscal Regime Sustainability," Papers 335, Banca Italia - Servizio di Studi.
    2. Jan J.G. Lemmen & Charles A.E. Goodhart, 1999. "Credit Risks and European Government Bond Markets: A Panel Data Econometric Analysis," Eastern Economic Journal, Eastern Economic Association, vol. 25(1), pages 77-107, Winter.
    3. Kerstin Bernoth & Jürgen von Hagen & Ludger Schuknecht, 2004. "Sovereign risk premia in the European government bond market," Working Paper Series 369, European Central Bank.
    4. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
    5. Axel Schimmelpfennig & Nouriel Roubini & Paolo Manasse, 2003. "Predicting Sovereign Debt Crises," IMF Working Papers 03/221, International Monetary Fund.
    6. Stephen M. Miller & Frank S. Russek, 1991. "The Temporal Causality Between Fiscal Deficits And Interest Rates," Contemporary Economic Policy, Western Economic Association International, vol. 9(3), pages 12-23, 07.
    7. Adrian Orr & Malcolm Edey & Michael Kennedy, 1995. "The Determinants of Real Long-Term Interest Rates: 17 Country Pooled-Time-Series Evidence," OECD Economics Department Working Papers 155, OECD Publishing.
    8. Miller, Stephen M. & Russek, Frank S., 1996. "Do federal deficits affect interest rates? Evidence from three econometric methods," Journal of Macroeconomics, Elsevier, vol. 18(3), pages 403-428.
    9. Paolo Paesani & Rolf Strauch & Manfred Kremer, 2006. "Public debt and long-term interest rates - the case of Germany, Italy and the USA," Working Paper Series 656, European Central Bank.
    10. Caporale, Guglielmo Maria & Williams, Geoffrey, 2002. "Long-term nominal interest rates and domestic fundamentals," Review of Financial Economics, Elsevier, vol. 11(2), pages 119-130.
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    Cited by:
    1. Beetsma, Roel & Giuliodori, Massimo & Klaassen, Franc, 2009. "Temporal aggregation and SVAR identification, with an application to fiscal policy," Economics Letters, Elsevier, vol. 105(3), pages 253-255, December.
    2. Giancarlo Corsetti & Keith Kuester & Andre Meier & Gernot J. Muller, 2011. "Soverign risk and the effects of fiscal retrenchment in deep recessions," Working Papers 11-43, Federal Reserve Bank of Philadelphia.
    3. Gerhard Reitschuler & Rupert Sendlhofer, 2011. "Fiscal policy, trigger points and interest rates: Additional evidence from the U.S," Working Papers 2011-23, Faculty of Economics and Statistics, University of Innsbruck.
    4. Guglielmo Maria Caporale & Alessandro Girardi, 2011. "Fiscal Spillovers in the Euro Area," Discussion Papers of DIW Berlin 1164, DIW Berlin, German Institute for Economic Research.
    5. Beetsma, Roel & Giuliodori, Massimo, 2009. "The Macroeconomic Costs and Benefits of the EMU and other Monetary Unions: An Overview of Recent Research," CEPR Discussion Papers 7500, C.E.P.R. Discussion Papers.
    6. Corsetti, Giancarlo & Kuester, Keith & Meier, André & Müller, Gernot, 2012. "Sovereign Risk, Fiscal Policy, and Macroeconomic Stability," CEPR Discussion Papers 8779, C.E.P.R. Discussion Papers.
    7. Salvatore Dell’Erba, Sergio Sola, 2011. "Expected fiscal policy and interest rates in open economy," IHEID Working Papers 07-2011, Economics Section, The Graduate Institute of International Studies.
    8. International Monetary Fund, 2011. "Public Debt in Advanced Economies and its Spillover Effects on Long-term Yields," IMF Working Papers 11/210, International Monetary Fund.
    9. Eduardo López E. & Víctor Riquelme P. & Ercio Muñoz S., 2011. "Long – Term Interest Rate and Fiscal Policy," Working Papers Central Bank of Chile 633, Central Bank of Chile.
    10. Bernd Hayo & Matthias Uhl, 2012. "Regional Effects of Federal Tax Shocks," MAGKS Papers on Economics 201217, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    11. C. Kerdrain & V. Lapègue, 2011. "Restrictive Fiscal Policies in Europe: What are the Likely Effects?," Documents de Travail de la DESE - Working Papers of the DESE g2011-17, Institut National de la Statistique et des Etudes Economiques, DESE.

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