My take-away from the blog post is this : you claim that showing a correlation between EU countries' debt levels and bond interest rates has policy implications for the USA.

This is a political assertion, and frankly laughable from an economics point of view. The graph from your blog (below) demonstrates that, as long as the market was under the illusion that the Euro was a normal currency, debt levels had no influence on interest rates for member countries. It was precisely when it became apparent that the ECB was unwilling to function as a true central bank, and was in fact prepared to let member countries' economies go to the wall, that the correlation between debt levels and interest rates becomes apparent.

_{It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II}

You seem to introduce this tipping point - not defined - after the fact to defend your conclusions.

You claim, in your linked post, that using a fixed-effect estimator suffices to account for the effect of being a member of the Eurozone.

This is obviously false. In order to properly account for higher-order effects, you would have needed cross-terms of a Eurozone dummy with each of your independent variables. Just as (and for the same reason) you include cross-terms between the independent variables in question.

As you correctly note, this would have reduced the statistical power of your test. You are incorrect about the magnitude of the reduction, however: Including Eurozone dummy cross-terms would increase the number of estimated coefficients by only five, not one hundred as you allege.

But more fundamentally, the fact that your data is insufficient to power a proper estimator does not in any way, shape or form justify using an obvious misspecification. In point of fact, using an obvious misspecification to generate fake statistical power is a strong indicator of pseudoscience in action, and hence an argument in favor of the original diary's conclusion.

- Jake

Friends come and go. Enemies accumulate.

It is true that an unanticipated inflation would succeed in bringing the real debt burden down. But as soon as creditors become concerned that this is the way the problem will be resolved, nominal rates will rise

And indeed, the central bank should set interest rates for all maturities: If the central bank does not do so, the long-maturity end of the yield curve depends exclusively on animal spirits and expectations about future central bank policy.

But either way, there is no connection to the government budget, let alone any economic fundamentals. At all.

- Jake

Friends come and go. Enemies accumulate.