More on public debt and the rate of interest

An important point in the conservative (sound finance) argument against the increase in public debt, and the need for fiscal adjustment is that higher debt-to-GDP ratios would eventually lead to higher real interest rates.  In other words, the increase in debt would imply that economic agents would demand remuneration for holding government bonds.  The figure below shows the correlation between the change in public debt and the real rate of interest on bonds, between 1981 and 2009.

The result shows that an increase in the debt-to-GDP ratio of 1% leads to an increase of the real rate of interest on bonds os 0.07%.  In other words, the effect is in economic terms insignificant.  Much ado about nothing.

PS: As Nate Cline and Franklin Serrano kindly noticed, causality most likely runs from the rate of interest to debt.  Sure thing; the point here is just to note that even if the conservative point was correct, the actual effect would be insignificant.


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