Sustainability of Fiscal Deficits: The US Experience 1929-2004

Ananda Jayawickrama, Tilak Abeysinghe
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Recurrent large fiscal deficits and accumulating public debt frequently ring alarm bells around the world on the sustainability of U.S. federal fiscal policy. The present-value borrowing constraint, which states that, for the fiscal policy to be sustainable the current debt stock should match the discounted sum of expected future primary surpluses, provides a framework for analysing fiscal sustainability. Incorporating rational expectations we extend the methodology developed by Hamilton and Flavin (1986) to test the sustainability hypothesis in a cointegrating framework that can accomodate both stationary and non-stationary variables. Our model predicts dynamically diverse episodes of the debt series extremelly well. Our results support the hypothesis that the U.S. government is solvent despite the large increase in debt stock in recent years.