Does Foreign Debt Financing Raise Rates More? New Fed Paper

In the U.S., massive government deficits in 2008 and 2020 were offset by surging private sector savings, leaving the current account deficit – the measure of total national borrowing – stable at under 3% of GDP. That offset explains why rates did not rise, the authors said.

Japan tells the same story in extreme form. Private sector savings have more than offset government borrowing since the 1990s, producing a current account surplus and a net foreign asset position of 82% of GDP despite gross debt at 251%. New government debt there is easily financed at home.

The pattern is now shifting. The U.S. current account deficit, which averaged under 2% of GDP before the pandemic, is near 4% today. Government deficits run around 8% of GDP. Private sector savings, while still positive, have steadily declined from their 2020-21 peaks.

The paper regresses 10-year yields on two-year-ahead OECD forecasts of government debt, deficits, current accounts, and net foreign asset positions, following a methodology from economists Joseph Gruber and Steven Kamin. A 1-percentage-point rise in debt or deficits financed abroad raises rates more than the same rise financed at home, the estimates show.

Davis is an assistant vice president in the Dallas Fed's research department. Derr is an outreach advisor in community engagement.