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Admissible Surplus Dynamics and the Government Debt Puzzle

Author

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  • Collin-Dufresne, Pierre
  • Hugonnier, Julien
  • Perazzi, Elena

Abstract

Is it possible to reconcile the procyclical Government surplus dynamics with the ‘safe asset status’ of sovereign Debt? In an arbitrage-free market, if the aggregate debt value satisfies a transversality condition that rules out ‘bub- bles’, then it should equal the present value of future government surpluses. This relation seems to fail when the surplus process is calibrated to histor- ical data in the US (Jiang, Lustig, van Nieuwerburgh, and Xiolan (2022)). However, we show that when the government issues only safe bonds in an incomplete but arbitrage-free market, then not all surplus processes are ad- missible in the sense that they are consistent with both the dynamic budget constraint and a transversality condition. We propose a class of admissi- ble surplus processes that matches empirical properties of US government spending and tax claims without generating a ‘debt valuation puzzle.’

Suggested Citation

  • Collin-Dufresne, Pierre & Hugonnier, Julien & Perazzi, Elena, 2024. "Admissible Surplus Dynamics and the Government Debt Puzzle," CEPR Discussion Papers 19427, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:19427
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    More about this item

    Keywords

    Transversality condition; Government debt;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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