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How do governments respond to interest rates?
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Orientador(es)
Resumo(s)
We explore the optimal and actual responses of fiscal policy to changes in the interest rate on newlyissued
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 percentagepoint
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.
Descrição
Palavras-chave
primary balance debt (marginal and effective) interest rate maturity structure smoothing valuation effect
Contexto Educativo
Citação
Klaassen, Franc, Roel Beetsma e João Tovar Jalles (2023). "How do governments respond to interest rates?". REM Working paper series, nº 0280/2023
Editora
ISEG - REM - Research in Economics and Mathematics