The demand for government debt

BIS Working Papers  |  No 1105  | 
08 June 2023
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 |  71 pages



We investigate how central bank balance sheet policies affect investor demand for government debt. As central banks embark on quantitative tightening (QT) to shrink their balance sheets, how different sectors will absorb government debt will largely depend on how sensitive their demand is to changes in the yields (or prices) of government bonds. We study compositional shifts in the investors that hold government debt in the euro area, Japan, the United Kingdom and the United States, and ask how different investor groups would respond under QT.


We estimate the yield sensitivity of demand for government bonds across different sectors and how this shapes the way that the government bond market adjusts under QT. To set the stage, we first run regressions that measure the marginal absorption by different investor groups as the total amount of government debt outstanding changes. We then draw on a demand system approach to compute the yield sensitivity. To account for any endogeneity between latent demand by various investor groups and government bond yields, we rely on monetary policy surprises as instruments for the yields in two-stage least squares regressions.


We estimate that a 1 percentage point increase in long-term yields leads to an 11% increase in the demand by non-central bank players for US Treasury securities. Based on estimates of the yield elasticity of different sectors, we infer the market-clearing yields under different quantitative tightening scenarios. For example, we find that, all else constant, a hypothetical reduction in the central bank balance sheet of around $215 billion leads to an increase in long-term bond yields by 10 basis points in the United States. Our estimates are quantitatively close to those for the euro area and they are also in more or less the same ballpark as estimates of the impact of quantitative easing obtained via other methods.


We document that the sectoral composition and marginal buyers of government debt differ notably across jurisdictions and have evolved significantly over time. Focusing on the United States, we estimate the yield elasticity of demand across sectors using instrumental variables constructed from monetary policy surprises. Our estimates point to a 11% increase in the demand by non-central-bank players for a 1 percentage point increase in long-term yields. Hence, a hypothetical reduction in the central bank balance sheet of around $215 billion increases longterm yields by 10 basis points. We find commercial banks, foreign private investors, pension funds, investment funds, and insurance companies to be the sectors whose demand is most sensitive to changes in long-term yields, but to varying degrees. Heterogeneous elasticities imply compositional shifts in the holders of government debt as central banks normalize balance sheets, which has policy implications.

JEL classification: E58, G11, G21, G23, H63

Keywords: government debt, demand, yield elasticity, quantitative easing, quantitative tightening