Working Paper Revision

Revisiting the Interest Rate Effects of Federal Debt

Abstract: This paper revisits the relationship between federal debt and interest rates, which is a key input for assessments of fiscal sustainability. Estimating this relationship is challenging due to confounding effects from business cycle dynamics and changes in monetary policy. A common approach is to regress long-term forward interest rates on long-term projections of federal debt. We show that issues regarding nonstationarity have become far more pronounced over the last 20 years, significantly biasing the recent estimates based on this methodology. Estimating the model in first differences addresses these concerns. We find that a 1 percentage point increase in the debt-to-GDP ratio raises the 5-year-ahead, 5-year Treasury rate by about 3 basis points, which is statistically and economically significant and highly robust. Roughly three-quarters of the increase in interest rates reflects term premia rather than expected short-term real rates.

JEL Classification: E43; E63; H63;

https://doi.org/10.24149/wp2513r1

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Working Papers

Publication Date: 2025-07-09

Number: 2513

Related Works

• Working Paper Revision (2025-07-09) : You are here.
• Working Paper Original (2025-04-23) : Revisiting the Interest Rate Effects of Federal Debt