Debt and real interest rates: Evidence from G20 countries

Abstract In this article, we examine the relationship between the debt and the ex‐post real interest rate on the basis of a sample from the G20 with the panel analysis, the panel threshold model, and a panel VAR model, particularly during times of high debt levels. In contrast to the results from the previous literature, our estimates suggest the negative connections between debt levels and real rates of interest: high debt levels reduce the current and expected real rate of interest, and the low real interest rate would raise the current and forward‐looking debt levels. Further investigations using the panel threshold model identify and quantify threshold values of debt on the forward real interest rate. In addition, we find that the threshold values of debt levels for advanced countries are far higher than the relevant values for emerging countries, which confirms the theory of “debt intolerance.” Third, the estimated impulse response functions from the panel VAR simulation support the significantly negative associations between debt levels and real interest rates. Fourth, the system GMM regressions and dynamic panel threshold tests show that our above conclusions are robust.