Debt, interest rates, and integration of financial markets

► Higher budget deficits raise interest rates, but financial integration offsets interest rate differentials. ► We test crowding out and the degree of integration of government bond markets using spatial modelling techniques. ► The crowding out of long term interest rates is limited: a 1% increase in the debt ratio raises domestic rates by 2 pp. ► Financial integration implies an important spillover effect via international bond markets of OECD countries. ► Emerging markets are not as well integrated into international capital markets, causing a stronger crowding out effect.