On the Limitations of Government Borrowing: a Framework for Empirical Testing

32 Pages Posted: 19 Jun 2004 Last revised: 19 Jun 2022

See all articles by James D. Hamilton

James D. Hamilton

University of California at San Diego; National Bureau of Economic Research (NBER)

Marjorie Flavin

University of California at San Diego; National Bureau of Economic Research (NBER)

Date Written: June 1985

Abstract

This paper seeks to distinguish empirically between two views on the limitations of government borrowing. According to one view, nothing precludes the government from running a permanent budget deficit, paying interest due on the growing debt load simply by issuing new debt, An alternative perspective holds that creditors would be unwilling to purchase government debt unless the government made a credible commitment to balance its budget in present value terms. We show that distinguishing between these possibilities is mathematically equivalent to testing whether a continuing currency inflation might be fueled by speculation alone or is instead driven solely by economic fundamentals. Empirical tests which have been developed for this economic question lead us to conclude that postwar U.S. deficits are largely consistent with the proposition that the government budget must be balanced in present-value terms.

Suggested Citation

Hamilton, James D. and Flavin, Marjorie, On the Limitations of Government Borrowing: a Framework for Empirical Testing (June 1985). NBER Working Paper No. w1632, Available at SSRN: https://ssrn.com/abstract=336355

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Marjorie Flavin

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