Foreign Borrowing Fuels Interest Rate Volatility

A new study by researchers at the Federal Reserve Bank of Dallas has found that government debt financed through foreign borrowing can have a greater impact on interest rates than debt financed through domestic savings.

The research, led by Scott Davis and Lillian Derr, analyzed data from 19 developed countries and found that countries with high levels of international debt tend to borrow more cheaply than those with low levels of international debt.

The study's findings help explain why the surge in government debt since the 2008 Global Financial Crisis did not result in a corresponding increase in interest rates. Despite average gross government debt increasing from 59% of GDP in 2007 to 90% in 2024, government bond yields remained low until the post-pandemic inflation surge beginning in 2022.

The researchers attributed this phenomenon to increased private-sector savings during both the financial crisis and the pandemic. However, they noted that this dynamic has begun to change, with U.S. government budget deficits now around 8% annually and private-sector net savings declining from its 2020-21 levels.