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Debt, deficits and interest rates

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  • Christopher D. Cotton

Abstract

This paper identifies how a rise in the deficit/debt impacts interest rates by looking at the high‐frequency response of interest rates to fiscal surprises. The fiscal surprises are the unexpected components of deficit releases and the changes in official forecasts by the Congressional Budget Office and by the Office of Management and Budget. The paper estimates that a rise in the deficit‐to‐GDP ratio of 1 percentage point raises the 10‐year nominal interest rate by 8.1 basis points. The response is similar quantitatively for other Treasury maturities and for corporate debt interest rates. The paper also investigates which theoretical channel drives this relationship, and whether surprises affect interest rate expectations or the term premium. These results are used to estimate how recent spending may have affected interest rates.

Suggested Citation

  • Christopher D. Cotton, 2024. "Debt, deficits and interest rates," Economica, London School of Economics and Political Science, vol. 91(363), pages 911-943, July.
    • Handle: RePEc:bla:econom:v:91:y:2024:i:363:p:911-943
    DOI: 10.1111/ecca.12521
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    References listed on IDEAS

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