Working Paper: CEPR ID: DP17341
Authors: Zhengyang Jiang; Hanno Lustig; Stijn van Nieuwerburgh; Mindy Xiaolan
Abstract: We use discounted cash flow analysis to measure a country's fiscal capacity. Crucially, the discount rate applied to projected cash flows includes a GDP risk premium. We apply our valuation method to the CBO's projections for the U.S. federal government's deficit between 2022 and 2051 and debt in 2051. In spite of low rates, our current measure of U.S. fiscal capacity is lower than the debt/GDP ratio. Because of the backloading of projected surpluses, the duration of the surplus claim far exceeds the duration of the outstanding Treasury portfolio. This duration mismatch exposes the government to the risk of rising rates, which would trigger the need for higher tax revenue or lower spending. Reducing this risk by front-loading the surpluses also requires major fiscal adjustment.
Keywords: fiscal capacity; fiscal policy
JEL Codes: G12; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Low interest rates (E43) | U.S. fiscal capacity (H69) |
| Rising interest rates (E43) | Higher tax revenue or reduced spending (H29) |
| Duration mismatch (C41) | Necessity for fiscal adjustments (H69) |
| 100 basis point increase in yields (E43) | Permanent increase in surpluses of more than 2.9% of GDP in 2052 (H62) |
| Current low rates (E43) | Risks associated with duration mismatches (C41) |