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Working papers from the Economics Department of the OECD that cover the full range of the Department’s work including the economic situation, policy analysis and projections; fiscal policy, public expenditure and taxation; and structural issues including ageing, growth and productivity, migration, environment, human capital, housing, trade and investment, labour markets, regulatory reform, competition, health, and other issues.
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Explaining the Interest-Rate-Growth Differential Underlying Government Debt Dynamics
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- David Turner1, Francesca Spinelli1
- Author Affiliations
- 1: OECD, France
- 19 Dec 2011
- Bibliographic information
The differential between the interest rate paid to service government debt and the growth rate of the economy is a key concept in assessing fiscal sustainability. Among OECD economies, this differential was unusually low for much of the last decade compared with the 1980s and the first half of the 1990s. This paper investigates the reasons behind this profile using panel estimation on 23 OECD economies. The results suggest that the fall is partly explained by lower inflation volatility associated with the adoption of monetary policy regimes which credibly target low inflation, which might be expected to continue. However, the low differential is also partly explained by factors which are likely to be reversed in the future, including very low policy rates, the "global savings glut" and the effect which the European Monetary Union had in reducing long-term interest differentials in the pre-crisis period. The differential is also likely to rise in the future because the number of countries which have debt-to-GDP ratios above a threshold at which there appears to be an effect on sovereign risk premia has risen sharply. Moreover, debt is projected to increasingly rise above this threshold in most of these countries.
- government debt, interest rate, interest-rate-growth differential, fiscal sustainability
- JEL Classification:
- E43: Macroeconomics and Monetary Economics / Money and Interest Rates / Interest Rates: Determination, Term Structure, and Effects
- E62: Macroeconomics and Monetary Economics / Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook / Fiscal Policy
- H63: Public Economics / National Budget, Deficit, and Debt / Debt; Debt Management; Sovereign Debt
- H68: Public Economics / National Budget, Deficit, and Debt / Forecasts of Budgets, Deficits, and Debt