Working Paper: NBER ID: w29902
Authors: Zhengyang Jiang; Hanno Lustig; Stijn van Nieuwerburgh; Mindy Z. 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: No keywords provided
JEL Codes: H6; H63; H68
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Projected surpluses (H62) | U.S. fiscal capacity (H69) |
| Duration mismatch (C41) | fiscal capacity (E62) |
| Interest rates (E43) | fiscal capacity (E62) |
| Increase in interest rates (E43) | higher tax revenues or lower spending (H29) |
| Increase in yields (Q15) | Permanent increase in surpluses (H62) |
| Fiscal policy changes (E62) | management of fiscal capacity (E62) |