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We use discounted cash flow analysis to measure the projected fiscal capacity of the US federal government. We apply our valuation method to the Congressional Budget Office (CBO) projections for the US federal government’s primary deficits between 2022 and 2052 and projected debt outstanding in 2052. The discount rate for projected cash flows and future debt must include a GDP or market risk premium in recognition of the risk associated with future surpluses. Despite current low interest rates, we find that US fiscal capacity is more limited than commonly thought. Because of the back-loading of projected primary 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 interest rates, which would trigger the need for higher tax revenue or lower spending. Reducing this risk by front-loading primary surpluses requires a major fiscal adjustment.
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Can Deficits Finance Themselves?
We ask how fiscal deficits are financed in environments with two key features: (i) nominal rigidity, and (ii) a violation of Ricardian equivalence due to finite lives or liquidity constraints. In such environments, deficits can contribute to their own financing through two channels: a boom in real economic activity, which expands the tax base; and a surge in inflation, which erodes the real value of nominal government debt. Our main theoretical result establishes that this mechanism becomes more potent as fiscal adjustment is delayed, leading to full self‐financing in the limit: if the monetary authority does not lean too heavily against the fiscal stimulus, then the government can run a deficit today, refrain from tax hikes or spending cuts in the future, and still see its debt converge back to its initial level. We further demonstrate that a significant degree of self‐financing is achievable when the theory is disciplined by empirical evidence on marginal propensities to consume, nominal rigidities, the monetary policy reaction, and the speed of fiscal adjustment.
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- Award ID(s):
- 2314736
- PAR ID:
- 10593413
- Publisher / Repository:
- Econometrica
- Date Published:
- Journal Name:
- Econometrica
- Volume:
- 92
- Issue:
- 5
- ISSN:
- 0012-9682
- Page Range / eLocation ID:
- 1351 to 1390
- Format(s):
- Medium: X
- Sponsoring Org:
- National Science Foundation
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- Free Publicly Accessible Full Text
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Accepted Manuscript1.0
- Journal Article:
- https://doi.org/10.3982/ECTA21791
