Working Paper: NBER ID: w29931
Authors: Wei Jiang; Thomas J. Sargent; Neng Wang; Jinqiang Yang
Abstract: Distortions induce a benevolent government that must finance an exogenous expenditure process to smooth taxes. An optimal fiscal plan determines the marginal cost —p’ of servicing government debt and makes government debt risk-free. A convenience yield tilts debts forward and taxes backward. An option to default determines debt capacity. Debt-GDP ratio dynamics are driven by 1) a primary deficit, 2) interest payments, 3) GDP growth, and 4) hedging costs. We provide quantitative comparative dynamic statements about debt capacity, debt-GDP ratio transition dynamics, and time to exhaust debt capacity.
Keywords: government debt; taxation; debt sustainability; risk management; fiscal policy
JEL Codes: E44; E62; G12; H21; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal tax and government borrowing plan (H21) | marginal cost of servicing government debt (H63) |
| option to default (Y60) | government debt capacity (H63) |
| primary deficits, interest payments, GDP growth, and hedging costs (F34) | debt-to-GDP ratio dynamics (H68) |
| hedging costs (G13) | equilibrium debt capacity (H63) |
| limited commitment constraints (D10) | debt capacity (G32) |