Linear and Non-Linear Effects of Public Debt on Long Term Interest Rate

The main objective of this paper is to reassess the effect of public debt on long-term interest rate using panel data approach. It complements and extends the existing literature and in particular, the empirical framework employed in the paper by Ardagna, Caselli and Lane (2004) through exploring nonlinear effects of large fiscal deterioration by broadening the country sample and using different time horizon. Non-linear effects of public debt on GDP are estimated by calculating threshold value for public debt ratio using the methodology proposed by Hansen (1999). We find strong evidence that during the period of financial trouble or recession, having high public debt results in stronger significant effects on long term interest rates. While investigating the presence of non-linear relationship of Public debt ratio and long-term interest rates, we find strong evidence of non-linearity. Keywords: Public debt, sovereign rate, non-linear JEL Classification: E60, E6