Public Debt Levels and Real Interest Rates: Causal Evidence from Parliamentary Elections

We use close elections in parliamentary democracies as natural experiments to estimate public debt levels’ effects on real interest rates. We first estimate that an election in which no party achieves a parliamentary majority causes the debt-to-GDP ratio to increase by 21 percentage points over the following five years relative to an election in which one party barely secures a majority. We next estimate that real interest rates rise by a relative 119 basis points following such an election, implying that a one percentage point increase in the debt-to-GDP ratio causes a 5.6 basis point increase in real rates. That effect is larger than most previous estimates in the literature, suggesting the potential importance of simultaneity in the determination of real rates and government debt levels.