What keeps long-term U.S. interest rates so low?

•Short-term interest rate and inflation are the key long run drivers of long-term interest rates.•In the long run government debt has a negative effect on government bond yields.•However in the short run government debt has a positive effect on government bond yields.•The short run effect of debt on long-term interest rates conforms to the conventional wisdom.•The long run effect of debt on long-term interest rates aligns with charatalist perspectives.•A model based on Keynes’s ideas is presented to explain the dynamics of government bond yields.

U.S. government indebtedness and fiscal deficits increased notably following the Global Financial Crisis. Yet long-term interest rates and U.S. Treasury yields have remained remarkably low. What keeps long-term interest rates so low? This paper relies on a simple model, based on John Maynard Keynes’ view that the central bank's actions are the key drivers of long-term interest rates, to explain the behavior of long-term interest rates in the U.S. The empirical findings confirm that short-term interest rates are the most important determinants of long-term interest rates in the U.S. Contrary to conventional wisdom, higher government indebtedness has a negative effect on long-term interest rates, particularly on a long run basis. However, in the short run, higher government indebtedness has a positive effect on long-term interest rates. These are relevant for contemporary policy debates and macroeconomic theory.