Government Debt and the Long-Term Interest Rate: Application of an Extended Open-Economy Loanable Funds Model to Poland

This paper examines the behavior of the long-term interest rate in Poland based on a sample during 2001.Q1–2009.Q1. Both the demand for and supply of loanable funds are considered. Extending the openeconomy loanable funds model, this paper finds thatmore government debt as a percent of gdp leads to a higher long-term interest rate in Poland and that a higher real Treasury bill rate, more percent change in real GDP, a higher expected inflation rate, a higher world long-term interest rate, and depreciation of the zloty would increase the long-term interest rate in Poland. In the standard open-economy loanable funds model including the net capital inflow, the coefficient of the net capital inflow is positive and insignificant at the 10% level. Hence, the incorporation of the world interest rate and the nominal effective exchange rate in the model may better capture the behavior of the long-term interest rate in Poland.