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Debt and deficit fluctuations and the structure of bond markets

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  • Albert Marcet
  • Andrew Scott

Abstract

This paper tests for the market environment within which US fiscal policy operates, that is we test for the incompleteness of the US government bond market. We document the stochastic properties of US debt and deficits and then consider the ability of competing optimal tax models to account for this behaviour. We show that when a government pursues an optimal tax policy and issues a full set of contingent claims, the value of debt has the same or less persistence than other variables in the economy and declines in response to higher deficit shocks. By contrast, if governments only issue one-period risk free bonds (incomplete markets), debt shows more persistence than other variables and it increases in response to expenditure shocks. Maintaining the hypothesis of Ramsey behavior, US data conflicts.

Suggested Citation

  • Albert Marcet & Andrew Scott, 2001. "Debt and deficit fluctuations and the structure of bond markets," Economics Working Papers 558, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2003.
    • Handle: RePEc:upf:upfgen:558
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    More about this item

    Keywords

    Optimal fiscal policy; complete vs incomlete markets; tax smoothing; government debt; persistence of debt;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications

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