Expectations of Debt-to-GDP Dynamics : Modeling and Effects

This article starts with the conjecture that the subjective element of expectations is important for understanding and measuring the effects of government’s indebtedness on financial market rates. For this purpose we propose a modern model of extrapolative expectations for the Debt-to-GDP ratio. Based on expectations data elicited for the special purpose of this study under laboratory conditions we model time series for expected public debt for various countries. For the UK these data are then used in econometric estimates investigating the interest rate effect of the Debt-to-GDP ratio. In support of our conjecture we find that the expected change in indebtedness does indeed have the stronger and statistically significant effect on government long-term bond yields