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Revisiting the Interest Rate Effects of Federal Debt

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Abstract

This paper revisits the relationship between federal debt and interest rates, which is a key input for assessments of fiscal sustainability. Estimating this relationship is challenging due to confounding effects from business cycle dynamics and changes in monetary policy. A common approach is to regress long-term forward interest rates on long-term projections of federal debt. We show that issues regarding nonstationarity have become far more pronounced over the last 20 years, significantly biasing the recent estimates based on this methodology. Estimating the model in first differences addresses these concerns. We find that a 1 percentage point increase in the debt-to-GDP ratio raises the 5-year-ahead, 5-year Treasury rate by about 3 basis points, which is statistically and economically significant and highly robust. Roughly three-quarters of the increase in interest rates reflects term premia rather than expected short-term real rates.

Suggested Citation

  • Michael D. Plante & Alexander W. Richter & Sarah Zubairy, 2025. "Revisiting the Interest Rate Effects of Federal Debt," Working Papers 2513, Federal Reserve Bank of Dallas, revised 09 Jul 2025.
    • Handle: RePEc:fip:feddwp:99902
    DOI: 10.24149/wp2513r1
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    1. Edward Gamber & John Seliski, 2019. "The Effect of Government Debt on Interest Rates: Working Paper 2019-01," Working Papers 55018, Congressional Budget Office.
    2. Jeffrey Schafer, 2024. "Revisiting the Relationship Between Debt and Long-Term Interest Rates: Working Paper 2024-05," Working Papers 60314, Congressional Budget Office.
    3. Thomas Laubach, 2009. "New Evidence on the Interest Rate Effects of Budget Deficits and Debt," Journal of the European Economic Association, MIT Press, vol. 7(4), pages 858-885, June.
    4. Maxime Phillot, 2025. "US Treasury Auctions: A High-Frequency Identification of Supply Shocks," American Economic Journal: Macroeconomics, American Economic Association, vol. 17(1), pages 245-273, January.
    5. D’Amico, Stefania & Kim, Don H. & Wei, Min, 2018. "Tips from TIPS: The Informational Content of Treasury Inflation-Protected Security Prices," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 53(1), pages 395-436, February.
    6. Ardagna Silvia & Caselli Francesco & Lane Timothy, 2007. "Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-35, August.
    7. Phillips, Peter C B & Ouliaris, S, 1990. "Asymptotic Properties of Residual Based Tests for Cointegration," Econometrica, Econometric Society, vol. 58(1), pages 165-193, January.
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    Keywords

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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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