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Debt and deficit fluctuations and the structure of bond markets

Journal

Journal of Economic Theory

Subject

Economics

Publishing details

Journal of Economic Theory 2009 Vol 144:2 p 473-501

Authors / Editors

Marcet A;Scott A

Biographies

Andrew J Scott

Publication Year

2009

Abstract

We analyse the implications of optimal taxation for the stochastic behaviour of debt. We show that when a government pursues an optimal fiscal policy under complete markets, the value of debt has the same or less persistence than other variables in the economy and it declines in response to shocks that cause the deficit to increase. By contrast, under incomplete markets debt shows more persistence than other variables and it increases in response to shocks that cause a higher deficit. Data for US government debt reveals diametrically opposite results from those of complete markets and is much more supportive of bond market incompleteness.

Keywords

Complete vs incomplete markets; Debt management; Fiscal deficits; Government debt; Optimal fiscal policy; Tax smoothing

Available on ECCH

No


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