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What Has Financed Government Debt?

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  • Hess Chung

    ()
    (Indiana University Bloomington)

  • Eric Leeper

    ()
    (Indiana University Bloomington)

Abstract

Equilibrium models imply that the real value of debt in the hands of the public must equal the expected present-value of surpluses. Empirical models of fiscal policy typically do not impose this condition and often do not even include debt. Absence of debt from empirical models can produce non-invertible representations, obscuring the true present-value relation, even if it holds in the data. First, we show that small VAR models of fiscal policy may not be invertible and that expanding the information set to include government debt has quantitatively important implications. Then we impose the present-value condition on an identified VAR and characterize the way in which the present-value support of debt varies across types of fiscal shocks. The role of expected primary surpluses in supporting innovations to debt depends on the nature of the shock. Debt is supported almost entirely by changes in the present-value of surpluses for some fiscal shocks, but for other fiscal shocks surpluses fail to adjust, leaving a large role for expected changes in discount rates. Horizons over which debt innovations are financed are long---on the order of 50 years or more.

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Bibliographic Info

Paper provided by Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington in its series Caepr Working Papers with number 2007-015.

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Length: 40 pages
Date of creation: Sep 2007
Date of revision:
Handle: RePEc:inu:caeprp:2007015

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Keywords: fiscal policy; present-value restriction; taxes; government spending;

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