Public spending and debt burdens are expected to drive up interest rates (Bellon and Gnewuch 2024, Benigno et al. 2024). However, since the 1980s, US long-term interest rates have exhibited a declining trend, while debt and deficits have steadily increased during most of these years. This trend has become particularly pronounced in the decade following the Global Crisis, marked by a continuous rise in the debt-to-GDP ratio, a sharp deterioration in fiscal deficits, and nominal interest rates reaching historically low levels (see Figure 1). This pattern of high debt, coupled with very low rates, has fostered a more benign perception of the costs associated with worsening fiscal positions (Blanchard 2019, Mankiw 2022, Bernanke and Blanchard 2023, Acalin and Ball 2023).
Figure 1 Debt, deficits, and long-term rates over time
Sources: CBO Historical Budget Data; FRED; and authors’ calculations.
In Furceri et al. (2025), we revisit the relationship between public debt and deficits and interest rates by extending the approach first proposed by Laubach (2009). In his seminal paper, Laubach emphasised the importance of examining the relationship between long-term expectations of interest rates and fiscal variables to mitigate endogeneity issues. The rationale is that deficits, debt, and interest rates expected to prevail several years in the future are little affected by short-term factors related to the current state of the business cycle, thus reducing confounding effects including those induced by counter-cyclical monetary policy and automatic fiscal stabilisers. We follow this approach and use the five-year-ahead projections of fiscal variables, rates, and GDP from Congressional Budget Office (CBO) reports throughout the analysis.
Another challenge to accurate identification arises from the fact that forecasts of long-term interest rates can influence projections of long-term debt and deficits, potentially resulting in inflated coefficients for the effects of debt and deficits on interest rates. That is, in the absence of a credible fiscal rule, higher projected interest rates will ‘automatically’ translate into higher projected debt levels. To mitigate this, our analysis considers the impact of primary deficits. We also extend Laubach’s approach by augmenting the set of control variables that could conceivably affect long-term interest rates and fiscal variables at the same time — such as population growth forecasts, risk aversion, medium-term real GDP growth forecasts, and international purchases of US debt. Finally, we control for potential trends affecting debt and interest-rate dynamics.
Public debt and deficits have significant impacts on long-term rates…
For the entire 50-year sample period (1976-2025) we examine, the estimated effects of debt and deficits on long-term interest rates are statistically and economically significant. Remarkably, the magnitudes are quite similar to those found in Laubach’s original study, despite roughly doubling the sample size. A 10% of GDP increase in expected debt is associated with an increase in long-term rates of between 20 and 30 basis points, while a 1% of GDP increase in the fiscal and primary deficit is associated with an increase in long-term rates of approximately 20 to 30 basis points. Interestingly, the effects of public debt (deficits) on term premia are of a similar magnitude — suggesting that increased risk premia provide compensation for larger fiscal risk.
Figure 2 The effect of debt and deficits on interest rates (percentage points)
Source: Authors’ estimates.
Notes: The charts show the percentage change in five measures of interest rates in response to 1% increase in debt/GDP, deficit/GDP, and primary deficit/GDP, respectively. The error bars show 90% confidence intervals. The regressions include additional control variables and span the period from 1976 to 2025. All point estimates are statistically significant.
…with the effects increasing in recent years
A key contribution of our study is demonstrating that the relationship between long-term rates and fiscal variables has evolved over time. We employ rolling-window regressions, setting the number of observations to 40, which means each coefficient is estimated using 20 years of data up to the date displayed in the chart.
Figure 3 illustrates our findings. The estimates indicate that the coefficients linking fiscal forecasts to long-term interest rates and term premia were close to zero for the two decades ending around 2005 to 2010, a period characterised by low projected debt and deficits. However, these effects began to increase markedly in recent years as fiscal positions deteriorated significantly.
Figure 3 Debt, deficit, and long-term interest rates: Rolling-window regressions (percentage points)
Source: Authors’ estimates.
Notes: Each coefficient results from a regression employing 40 observations. The rolling-window drops and adds one observation. Until 1990s this is equivalent to one year out and one year in; the interval depicted encompasses. Solid lines denote point estimates (in percentage points); dashed lines indicate one-standard deviation confidence bands.
Conclusion
Understanding how US fiscal policy impacts long-term interest rates is crucial for both academics and policymakers, especially in an environment of rising debt levels. Our study confirms that higher debt and deficits lead to increased long-term interest rates, with the effects becoming more pronounced over time. These findings suggest that projected increases in deficits and debt in the US are likely to further elevate debt servicing costs.
References
Acalin, J and L Ball (2023), “Reassessing the fall in US public debt after World War II”, VoxEU.org, 30 October.
Bellon, M and M Gnewuch (2024), “Dangerous Liaisons: Debt Supply and Convenience Yield Spillovers in the Euro Area”, VoxEU.org, 8 November.
Benigno, G, B Hofmann, G Nuño and D Sandri (2024), “The Natural Rate of Interest after the Pandemic”, VoxEU.org, 22 April.
Bernanke, B and O J Blanchard (2023), “What Caused the US Pandemic-Era Inflation?”, Working Paper Series WP23-4, Peterson Institute for International Economics.
Blanchard, O J (2019), “Public Debt and Low Interest Rates”, American Economic Review 109(4): 1197–1229.
Furceri, D, C Goncalves and H Li (2025), “The impact of debt and deficits on long-term interest rates in the US”, IMF Working Paper 2025/142.
Laubach, T (2009), “Evidence on the Interest Rate Effects of Budget Deficits and Debt”, Journal of the European Economic Association 7(4): 858–885.
Mankiw, N G (2022), “Government Debt and Capital Accumulation in an Era of Low Interest Rates”, Brookings Papers on Economic Activity 53(1): 219–231.