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Debt and Deficit Fluctuations and the Structure of Bond Markets

London Business School Economics Discussion Paper No. DP 2001/3

44 Pages Posted: 6 Nov 2001  

Andrew Scott

London Business School - Department of Economics; Centre for Economic Policy Research (CEPR)

Albert Marcet

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Centre for Economic Policy Research (CEPR)

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Date Written: May 25, 2001

Abstract

The aim of this paper is to test for the extent of incompleteness in the market for U.S government debt. We show that when a government pursues an optimal tax policy and issues a full set of contingent claims, the value of debt has the same or less persistence than other variables in the economy and declines in response to higher government expenditure shocks. Examining US data however reveals that debt is substantially more persistent than other variables and increases in response to adverse expenditure shocks. We show that this behaviour is best accounted for by a model of incomplete markets, where governments only issue one-period risk free bonds. We discuss the implications of this for the optimality of debt limits, debt management and assessing the sustainability of fiscal policy.

Suggested Citation

Scott, Andrew and Marcet, Albert, Debt and Deficit Fluctuations and the Structure of Bond Markets (May 25, 2001). London Business School Economics Discussion Paper No. DP 2001/3. Available at SSRN: https://ssrn.com/abstract=289331 or http://dx.doi.org/10.2139/ssrn.289331

Andrew Scott (Contact Author)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7706 6780 (Phone)
+44 20 7402 7875 (Fax)

Albert Marcet

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2740 (Phone)
+34 93 542 1746 (Fax)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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