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The Causal Effect of Debt on Interest Rates

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Abstract

This paper uses a natural experiment to measure the causal effect of an expected debt-financed fiscal stimulus on interest rates. We find that a 1 percentage point increase in the expected US debt-to-GDP ratio leads to an increase of about 1-2 basis points in the longer-run neutral rate (r∗) and of about 2–3 basis points in the 10-year Treasury term premium. Our results validate estimates from a common time-series approach that regresses long-term forward interest rates on long-term projections of government debt, where the exclusion restriction does not apply.

Suggested Citation

  • Abhik Bhatt & Anthony M. Diercks & Benjamin Eyal & Arsenios Skaperdas, 2026. "The Causal Effect of Debt on Interest Rates," Finance and Economics Discussion Series 2026-031, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:103341
    DOI: 10.17016/FEDS.2026.031
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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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