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Measuring U.S. Fiscal Capacity using Discounted Cash Flow Analysis

Author

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  • Jiang, Zhengyang
  • Lustig, Hanno
  • Van Nieuwerburgh, Stijn
  • Xiaolan, Mindy

Abstract

We use discounted cash flow analysis to measure a country's fiscal capacity. Crucially, the discount rate applied to projected cash flows includes a GDP risk premium. We apply our valuation method to the CBO's projections for the U.S. federal government's deficit between 2022 and 2051 and debt in 2051. In spite of low rates, our current measure of U.S. fiscal capacity is lower than the debt/GDP ratio. Because of the backloading of projected surpluses, the duration of the surplus claim far exceeds the duration of the outstanding Treasury portfolio. This duration mismatch exposes the government to the risk of rising rates, which would trigger the need for higher tax revenue or lower spending. Reducing this risk by front-loading the surpluses also requires major fiscal adjustment.

Suggested Citation

  • Jiang, Zhengyang & Lustig, Hanno & Van Nieuwerburgh, Stijn & Xiaolan, Mindy, 2022. "Measuring U.S. Fiscal Capacity using Discounted Cash Flow Analysis," CEPR Discussion Papers 17341, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17341
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    Cited by:

    1. YiLi Chien & Harold L. Cole & Hanno Lustig, 2023. "What about Japan?," Working Papers 2023-028, Federal Reserve Bank of St. Louis, revised 12 Jul 2024.

    More about this item

    Keywords

    Fiscal capacity; Fiscal policy;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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