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CEP discussion paper
Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries
Silvia Ardagna, Francesco Caselli and Timothy Lane January 2005
Paper No' CEPDP0670:
Full Paper (pdf)

JEL Classification: E62; E44; H62

Tags: government deficit; public debt; long-term interest rates

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.