Public Debt, Consumption Growth, and the Slope of the Term Structure
Charles A. Dice Center Working Paper No. 2018-23
89 Pages Posted: 14 Dec 2018 Last revised: 2 Nov 2021
Date Written: October 30, 2021
The debt-to-GDP ratio negatively predicts cumulative nominal consumption growth up to a 10-year horizon, resulting from the ratio's ability to forecast lower inflation and real growth. Moreover, the debt-to-GDP ratio is positively associated with yield spreads. I rationalize these facts in a model in which positive shocks to government debt cause lower inflation and growth, making bonds attractive assets. Furthermore, because longer-term bonds are less exposed to current debt shock than are shorter-term bonds, they are better hedges, resulting in high yield spreads in high-debt states. The model highlights the importance of fiscal risk in understanding the Treasury bond market.
Keywords: Government Debt, Fiscal Policy, Term Structure of Interest Rates, Endogenous Growth Risk
JEL Classification: E43, E44, E62, G12, G18, H32
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