Revisiting the “r-g” discussion over debt sustainability
In this paper Jiang et al. construct a tractable stochastic continuous-time model of
taxes and government debt with three specific features:
- Option for the government to default on its debt, in order to understand how non-commitment-to-repay assumption shapes a government’s equilibrium debt capacity.
- Complete financial spanning and risk premia: the assumption here is that government trades assets that allow it to insure itself against risk in GDP growth rates.
- A government that is impatient relative to the representative household that is paying taxes. Impatience is when the government’s discount rate exceeds the interest rate. This situation is consistent with the idea that US Treasury bonds carry a convenience yield that lowers the US cost of borrowing below a risk-free rate.
Optimal debt-GDP ratio dynamics are driven not only by three widely discussed forces, 1.) a primary deficit, 2.) interest payments, and 3.) GDP growth, but also by 4.) hedging costs. Hedging fundamentally alters debt transition dynamics and equilibrium debt capacity, which are at the center of the recent ‘r-g’ and debt sustainability discussions.
A p Theory of Government Debt and Taxes
Authors: Wei Jiang, Thomas J. Sargent, Neng Wang, Jinqiang Yang
From: Hong Kong University of Science and Technology, New York University, Columbia University, Shanghai University of Finance and Economics
On public debt revenue
In this paper, Ricardo Reis argues creditors give the government a discount (as government bonds are considered a store of value, a safe haven and trade in liquid markets) charging less on the public debt than that market rate. He defines debt revenue as the discount multiplied by the amount of debt. Debt revenue, he continues, actually saves the government the need to collect future taxes to repay a debt that grows at a lower rate than market returns. Yet, debt revenue has been ignored in economic analyses of debt sustainability.
Simple calculations suggest that this debt revenue term is large and may be sustaining most of the public debt outstanding in developed economies. Perhaps this accounts for the lack of a debt crisis in the United States and most other advanced economies in spite of debt/GDP ratios that are broaching record highs.
Debt Revenue and the Sustainability of Public Debt
Author: Ricardo Reis
From: London School of Economics
