Increasing public debt and the role of central bank independence for debt maturities

Abstract

Governments are interested in lengthening debt maturity to reduce fiscal, refinancing, and default risks. On the other hand, investors may worry that highly indebted governments will inflate away their debts when it is long-term. Based on a new panel dataset spanning from 1990–2016 for 28 OECD countries, the paper finds that governments prolong the average debt maturity, if debt ratios increase. Interestingly, the marginal effect of the debt ratio on average maturity is higher for countries with an independent central bank than for countries with a more politically dependent one. There are two possible explanations for this effect of central bank independence. First, an independent central bank reduces the inflation risk premium that longer maturities otherwise would have. Second, governments with independent central banks are unable to use monetary policy for inflating and reducing fiscal and interest rate shock burdens. Again, this calls for longer maturities to reduce the relevant risks.