How high public debt amplifies risk premia and inflation expectations

There is a point at which public debt is no longer merely a large number in a fiscal table. It begins to change how financial markets respond to new deficits. That amplification mechanism is at the heart of a recent BIS Bulletin on the Americas. Its central message is straightforward but consequential: when debt and interest burdens are already high, sovereign risk premia can react much more strongly to additional fiscal expansion, and those risk premia can in turn have a greater impact on short-term inflation expectations. This is not a story about a single magic debt threshold. It is a story about non-linearity, credibility and a shrinking margin for policy error in highly indebted economies.

Public debt at multi-decade highs

The starting point is unambiguous. Eduardo Amaral, Rafael Guerra, Alejandrina Salcedo, Pablo Tomasini and Christian Upper document that public debt has reached multi-decade highs in many economies across the Americas. Their descriptive sample covers 33 economies in North, Central and South America and the Caribbean. The long-run path reflects successive shock waves: Latin America's "lost decade" of the 1980s, later crises and currency depreciations, and most recently the Covid-19 pandemic.

During the 1980s the median debt-to-GDP ratio roughly doubled. After receding in the mid-1990s, it climbed back to around 60% of GDP by 2005. The pandemic subsequently pushed public debt in most economies to its highest level since 1960. In the current environment, the authors also point to high energy prices and pressure on governments to support households and firms, making fiscal space simultaneously more valuable and more constrained.

The regional average hides substantial heterogeneity. Debt-to-GDP ratios rose between 2015 and 2025 in 27 of the 33 economies. Around 40% experienced increases of more than 20 percentage points of GDP, while almost one third recorded rises of between 10 and 20 percentage points. High or rising debt is therefore not confined to a small set of crisis cases; it is a broad regional pattern.

Jamaica: debt dynamics are not destiny

Jamaica provides the most striking counterexample. Its public debt fell from a peak of 148% of GDP in 2012 to 68% in 2025. The Bulletin associates this achievement with well-designed fiscal rules, a collaborative approach to sharing the adjustment burden and sustained large primary surpluses. The example matters because it challenges fatalism: high debt is difficult to reverse, but not immutable.

At the same time, Jamaica is not a mechanical template for every country. Debt sustainability depends on growth, interest rates, the primary balance, expenditure rigidity, debt composition, currency exposure and the risk-bearing capacity of the financial system. The broader lesson is institutional: credible rules and sustained policy consistency can change the path of public debt.

Fig. 01: Public debt in the Americas has risen markedly over recent decades. In 27 of the 33 economies covered, the debt ratio was higher in 2025 than in 2015 [Source: Eduardo Amaral, Rafael Guerra, Alejandrina Salcedo, Pablo Tomasini and Christian Upper (2026), High public debt in the Americas: non-linear implications for risk premia and inflation expectations, BIS Bulletin No 133, Graph 1, p. 2; IMF; authors' calculations]

Debt stocks and interest burdens tell different stories

One of the Bulletin's strengths is its distinction between stocks and flows. The debt ratio measures the accumulated stock of liabilities. Interest payments, by contrast, show how much current fiscal capacity is absorbed by servicing those liabilities. The two need not move together. A government can have a broadly stable debt ratio and still face a sharp increase in interest costs if policy rates rise, the currency depreciates or maturing debt has to be refinanced at higher yields.

Across the region, public debt interest costs have generally increased over the past decade and have often outpaced fiscal revenues. The authors decompose the change into a debt effect and an implicit interest-rate effect. This matters because two economies with the same debt ratio can face very different fiscal constraints depending on the price, maturity and currency structure of their liabilities.

The analytical focus therefore shifts away from a single headline ratio. The relevant questions are not only how much a government owes, but how expensive that debt has become, how rapidly it needs to be refinanced and how much revenue is absorbed by interest payments. It is precisely the combination of a large debt stock and a high interest burden that can make fiscal shocks more potent.

Fig. 02: Public interest costs have risen in many economies across the Americas. In several countries, higher implicit financing costs have contributed substantially alongside higher debt levels [Source: Amaral et al. (2026), Graph 2, p. 3; IMF; authors' calculations]

The amplification effect: when an extra deficit becomes much more expensive

The empirical core of the study concerns the response of sovereign risk premia to fiscal expansion. The authors examine 21 emerging market and developing economies in the Americas using quarterly data from Q1 2015 to Q4 2025. EMBI spreads serve as the measure of sovereign risk premia. The econometric approach relies on panel local projections in the tradition of Jordà, separating observations with high and low debt or interest burdens. Importantly, "high" does not mean exceeding a universal debt threshold; it means being above the cross-country median in a given quarter.

The result is economically large. A fiscal deficit increase of 1% of GDP is associated with an increase in EMBI spreads that is almost three times as large in high-debt economies as in low-debt economies. The response is also stronger and more persistent when public interest burdens are high. The pattern survives the distinction between floating and non-floating exchange-rate regimes.

This gives practical meaning to the idea of fiscal space. The same amount of additional borrowing can produce very different second-round effects depending on initial conditions. In a low-debt economy, temporary fiscal expansion may prompt only a modest repricing. In an already stressed economy, it can trigger a reassessment of debt sustainability, raise funding costs and magnify the original fiscal impulse.

Fig. 03: Fiscal stress heightens the effect of an additional deficit on sovereign risk premia. The estimated response is substantially stronger when debt or interest burdens are high [Source: Amaral et al. (2026), Graph 3, p. 4; panel local projections for 21 economies; 90% confidence intervals]

Why a fixed exchange rate does not provide immunity

At first sight, one might expect flexible exchange rates to be the main transmission channel: higher risk premia trigger capital outflows, the currency depreciates, import prices rise and inflation expectations move up. Yet the Bulletin finds that the amplification of sovereign risk premia is present under both floating and non-floating exchange-rate regimes.

The reason is intuitive. A peg or managed exchange rate does not remove fiscal risk; it changes the way the risk appears. Higher sovereign premia can increase the perceived probability of a discrete devaluation. Authorities may need to use foreign-exchange reserves or impose tighter domestic financial conditions to defend the exchange-rate objective. Fiscal stress therefore migrates across balance sheets and policy instruments rather than disappearing.

From sovereign risk premia to inflation expectations

The second stage of the analysis asks what happens once sovereign risk premia have risen. For 16 economies with both EMBI data and short-term inflation expectations from professional forecasters, the authors estimate the response of one-year-ahead inflation expectations to a 100 basis point increase in risk premia.

When public debt is high, inflation expectations become significantly more sensitive to changes in sovereign risk premia. Again, the finding holds under both floating and non-floating exchange-rate arrangements. By contrast, the authors do not find persistent significant differences between high- and low-interest-burden economies in this second transmission stage. That distinction is important: debt and interest costs both amplify the first step from deficits to risk premia, but they do not necessarily amplify every subsequent link in exactly the same way.

The Bulletin discusses three plausible channels. First, higher sovereign risk can weaken the currency or raise devaluation expectations, feeding into import prices. Second, sovereign risk can spill over into bank funding costs, corporate borrowing rates and working-capital spreads even if the policy rate is unchanged. Third, when debt is already high, rising premia may increase fears that fiscal stress will ultimately be resolved partly through higher inflation, a more accommodative monetary stance or political pressure on the central bank. Credibility thus becomes a macroeconomic asset in its own right.

Fig. 04: When public debt is high, short-term inflation expectations respond more strongly to a rise in sovereign risk premia. High interest costs alone do not produce a persistently significant difference in this second-stage response [Source: Amaral et al. (2026), Graph 4, p. 5; panel local projections for 16 economies; inflation expectations from Consensus Economics; 90% confidence intervals]

No magic debt threshold

The study is especially useful because it does not claim to identify a universal tipping point. High debt is defined relative to the within-quarter median of the sample. The results demonstrate state-dependent non-linearity, not a law of nature at 60%, 80% or 100% of GDP.

That distinction matters for public debate. Debt sustainability depends on nominal and real growth, interest rates, maturity profiles, currency composition, primary balances, expenditure flexibility, institutional credibility and the resilience of the financial system. A single debt ratio cannot compress all of these dimensions without losing essential information.

The warning nevertheless remains powerful. As the starting burden rises, the margin for error can shrink. Not every new expenditure programme will trigger a crisis, but the probability of an outsized market response increases when investors begin to reassess the credibility of the fiscal path.

What the study establishes – and what it leaves open

The authors carry out several robustness exercises. For Brazil, Chile, Colombia, Mexico and Peru, the non-linear results remain when five-year credit default swap spreads are used instead of EMBI spreads. They also test whether the interest-burden effects are simply proxies for high debt, and vice versa.

There are, however, important limitations. EMBI spreads primarily capture hard-currency sovereign risk; local-currency sovereign spreads would be a valuable extension. The high-versus-low classification is sample-relative and does not provide a universal debt ceiling. And while the authors discuss plausible channels from risk premia to inflation expectations, their analysis does not identify the precise mechanism directly. The 90% confidence intervals also call for a probabilistic rather than deterministic reading.

The Bulletin should therefore not be read as a crisis forecast. It is an empirical warning about asymmetric responses: in a high-debt environment, fiscal mistakes can become more expensive because markets, exchange rates, financing conditions and inflation expectations may react in a more tightly coupled way.

Fiscal policy: consolidate without destroying growth

The policy conclusion is disciplined and credible fiscal policy, but not indiscriminate austerity. Consolidation should protect long-term growth potential, preserve productive public investment and essential services where possible, and be complemented by structural reforms that raise potential output.

Credibility must also be institutionalised through clear rule-based fiscal frameworks, transparent reporting and credible enforcement. One of the Bulletin's most important messages is that institutions are effective only when they operate in practice rather than merely existing on paper.

The policy debate therefore moves beyond the question of how much deficit is permissible. The more relevant question is whether the entire adjustment path is credible. Markets assess not only today's debt level but also a government's capacity to absorb future shocks, improve primary balances and reconcile fiscal sustainability with growth.

Central bank independence as a macroeconomic firewall

The higher public debt becomes, the more politically uncomfortable high interest rates may be. That is precisely why central bank independence becomes more valuable. If market participants begin to suspect that monetary policy could be subordinated to fiscal needs, higher sovereign risk premia can feed more rapidly into inflation expectations.

The BIS authors therefore place a clear premium on maintaining the price-stability mandate and protecting central banks from political pressure. In a highly indebted economy, central bank independence is not merely an institutional virtue; it is part of the fiscal risk-management architecture because it limits expectations that debt problems will eventually be monetised.

Summary and outlook

The study changes the way high public debt should be viewed. The problem is not simply the absolute stock of liabilities but the possibility of non-linear amplification. An additional deficit can trigger a much stronger repricing of sovereign risk in a high-debt economy than in a fiscally comfortable one. That repricing can then have a stronger effect on short-term inflation expectations when public debt is already elevated.

For governments, the implication is that fiscal space is not static. It can narrow abruptly when credibility weakens. For central banks, the quality of fiscal policy shapes the environment in which price stability must be maintained. For investors, debt ratios, interest burdens and deficits should be analysed as interconnected state variables in a dynamic risk system rather than as isolated indicators.

The outlook is neither alarmist nor complacent. High debt does not inevitably lead to crisis. But it can make responses to new shocks less linear and policy mistakes more expensive. The critical resource is credibility, built through robust fiscal frameworks, transparent decisions, growth-friendly consolidation and independent monetary policy.

Bibliography and Further Reading:

• Amaral, E.; Guerra, R.; Salcedo, A.; Tomasini, P.; Upper, C. (2026): High public debt in the Americas: non-linear implications for risk premia and inflation expectations. BIS Bulletin No 133, 19 August 2026.
• Aguilar, A.; Cantú, C.; Guerra, R. (2023): Fiscal and monetary policy in emerging market economies: what are the risks and policy trade-offs? BIS Bulletin No 71.
• Arslanalp, S.; Eichengreen, B.; Henry, P. B. (2024): Sustained debt reductions: the Jamaica exception. NBER Working Paper No 32465.
• Bank for International Settlements (2026): High public debt and shifting financial markets: challenges for central banks. Annual Economic Report 2026, Chapter II.
• Eichengreen, B.; Menuet, M.; Donnat, G. (2026): From stocks to flows: debt service and fiscal sustainability. CEPR Discussion Paper No 21723.
• Jordà, Ò. (2005): Estimation and inference of impulse responses by local projections. American Economic Review, 95(1).
• Romeike, F. (2026): Wie Staaten bankrott gehen – Die Gesetzmäßigkeit der Risikotragfähigkeit [How Countries Go Bankrupt – The Law of Risk-Bearing Capacity], in: ZInsO FOKUS (Zeitschrift für das gesamte Insolvenz- und Sanierungsrecht) [Journal on All Aspects of Insolvency and Restructuring Law], Vol. 29, No. 5/2026, Jan. 29, 2026, pp. 183–195.