Fiscal Deficits, Public Debt, and Sovereign Bond Yields

Abstract

The recent sharp increase in fiscal deficits and government debt in many countries raises questions regarding their impact on long-term sovereign bond yields. While economic theory suggests that this impact is likely to be adverse, empirical results have been less clear cut, have generally ignored nonlinear effects of deficits and debt through some other key determinants of yields, and have been mostly confined to advanced economies. This paper reexamines the impact of fiscal deficits and public debt on long-term interest rates during 1980 - 2008, taking into account a wide range of country-specific factors, for a panel of 31 advanced and emerging market economies. It finds that higher deficits and public debt lead to a significant increase in long-term interest rates, with the precise magnitude dependent on initial fiscal, institutional and other structural conditions, as well as spillovers from global financial markets. Taking into account these factors suggests that large fiscal deficits and public debts are likely to put substantial upward pressures on sovereign bond yields in many advanced economies over the medium term.Budget deficits;Public debt;Bonds;Interest rates;Fiscal policy;Developed countries;Emerging markets;Cross country analysis;Economic models;bond yields, fiscal balance, fiscal deficits, government bond, term bond, long-term bond yields, primary fiscal balance, government bond yields, fiscal variables, sovereign bond, debt service, financial market, global bond, financial markets, fiscal balance in percent, government bonds, fiscal conditions, bond markets, fiscal indicators, fiscal stance, fiscal consolidation, fiscal expansions, fiscal adjustment, sovereign bond markets, public bond, crowding out, fiscal discipline, fiscal balances, fiscal imbalances, public finances, bond yield curve, fiscal rules, financial systems, primary fiscal deficit, fiscal solvency, financial globalization, budget constraint, fiscal risks, fiscal frameworks, fiscal institutions, fiscal retrenchments, tax cuts, fiscal sustainability, fiscal adjustments, fiscal vulnerability, fiscal affairs department, domestic bond, stock market, fiscal problems, tax revenues, foreign capital, primary deficit, nominal interest rate, fiscal agencies, fiscal adjustment efforts, stock market volatility, increase in debt service, fiscal stability, fiscal developments, government bond markets, global bond markets, tax policy, aggregate demand, financial sector