Debt and Deficit Fluctuations and the Structure of Bond Markets

47 Pages Posted: 15 Nov 2001

See all articles by Albert Marcet

Albert Marcet

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

Andrew Scott

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

Multiple version iconThere are 2 versions of this paper

Date Written: October 2001

Abstract

The aim of this Paper is to test for the extent of incompleteness in the market for US 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.

Keywords: Bond markets, debt, deficits, fiscal policy, optimal taxation

JEL Classification: E62, H63

Suggested Citation

Marcet, Albert and Scott, Andrew, Debt and Deficit Fluctuations and the Structure of Bond Markets (October 2001). Available at SSRN: https://ssrn.com/abstract=290908

Albert Marcet (Contact Author)

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)

London
United Kingdom

Andrew Scott

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)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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