Government Debt, Interest Rates And International Capital Flows: Evidence From Cointegration
This paper examines the impact of government debt on interest rates in the United States, Germany, the United Kingdom and Canada. It builds on the general portfolio balance framework which allows for both direct and indirect tests of the link between public debt and interest rates, and uses the Johansen-Juselius multivariate cointegration techniques to perform these tests. Indirect tests in this model consist of investigating the debt impact on interest rates through the effects of debt on the exchange rate and money demand. The evidence indicates that both transitory and permanent changes in the level of government debt cause higher domestic interest rates and money demand and appreciate the exchange rate in all four countries under study.
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