Interest rate-growth differential and government debt dynamics

The difference between the average interest rate that governments pay on their debt and the nominal growth rate of the economy (i-g) is a key variable for debt dynamics and sovereign sustainability analysis. Recently, i-g has turned negative in most advanced economies, including euro area sovereigns. Empirically, the relevant interest rate-growth differential for public debt dynamics above has been positive for advanced mature economies over longer periods. In particular, i-g can quickly reverse in crisis times, especially for countries with high debt burdens and/or not perceived by markets as safe havens. Overall, In the euro area, the current low interest rate-growth differentials on government debt should not be taken as an incentive for higher debt levels, especially where fiscal space is constrained. JEL Classification: H68, E62, E4