Abstract

Purpose: The article aims at analyzing the functional form of the relation between the level of public debt and the government bond yields in both developed and developing countries. A surge in public indebtedness following the financial crisis in 2008-2010 undermined the credibility of sovereigns in the credit markets. As a result, the government bond yields have risen, thus amplifying the problem of rapidly expanding public debts.
The purpose of the article is to estimate the threshold value of government debt above which its service costs rapidly increase.

Methodology: The relation between the 10-year government bond real interest rate and the level of debt is investigated with the use of spline regression with cubic splines. The regression model is estimated using annual data for 66 countries that spans between the years 1980-2010. An additional analysis is conducted for the last decade and after splitting the sample into high-income and catching-up countries.

Findings: In the sample that covers all countries and the whole 1980-2010 period no relation between the level of debt and interest rate has been detected. In the years 2001-2010 the threshold value of debt above which the real interest rate starts to grow rapidly is estimated to be around 150% of GDP in catching-up countries and about 110% of GDP in high-income countries.

Research implications: An analysis of the impact of fiscal policy on the level of interest should take into account the likely non-linearity of the relationship.

Originality: Spline regression has not yet been used in the analysis of the relation between debt and interest rate.

Keywords