 How do governments respond to interest rates?Franc Klaassen, Roel Beetsma and Joao Jalles No 18257, CEPR Discussion Papers from Centre for Economic Policy Research Abstract: We explore the optimal and actual responses of fiscal policy to changes in the interest rate on newly-issued public debt (the “marginal interest rate†). We set up a simple theoretical framework with a government aiming to smooth public consumption over time. The distinctive feature is that the government issues debt of different maturities. This introduces a “valuation effect†that has received little attention so far: a rise in the marginal interest rate increases the rate of discounting and, thus, lowers the value of non-maturing debt, which relaxes the budget constraint, thereby inducing a fall in the primary balance. Still, the framework predicts that the total effect of a rise in the marginal interest rate is an increase in the primary balance. Estimates for developed countries suggest that a 1 percentage-point higher marginal interest rate leads, on average, to roughly a 1 percentage-point higher primary balance. These findings are consistent with governments smoothing the impact of changes in the marginal interest rate and exploiting the valuation effect. Finally, estimates suggest a role for the average (or “effective†) interest rate on outstanding debt. JEL-codes: E4 E62 H6 (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:18257 Ordering information: This working paper can be ordered from Access Statistics for this paper More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK. |
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