Public Interest Payments and Bond Yields: A Panel Data Estimation for the Eurozone

Abstract

Governments with high public debt risk that investors raise doubts about their ability to repay their debt since interest payments constitute an increasing share of public budgets. High interest payments may then fuel bond yields on secondary markets and subsequently lead to rising refinancing costs. This could precipitate a self-fulfilling prophecy according to which investors’ doubts about a default make the default more probable. Although there already are extensive research results on determinants of bond yields, the role of governments’ interest payments has not been duly taken into account. 

This paper tests whether the size of public interest payments had an influence on government bond yields during the European debt crisis. There seems to be indeed evidence that higher interest quotas and increasing interest-growth differentials entail higher bond yields.