Government debt and risk premia

In the U.S. and other advanced countries, government debt raises risk premia, boosting short- and long-term market returns. Debt raises bond premia and lowers risk-free rates. Existing government debt theories cannot explain this. Recent evidence demonstrates that higher risk premia offset fiscal risk. Fiscal policy becomes unpredictable and ineffective during excessive debt, potentially causing debt crises. Equilibrium models quantify these mechanisms.

Image courtesy of interviewee. December 19, 2023

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