Henning Bohn

The Behavior of U. S. Public Debt and Deficits

How do governments react to the accumulation of debt? Do they take corrective measures, or do they let the debt grow? Whereas standard time series tests cannot reject a unit root in the U. S. debt-GDP ratio, this paper provides evidence of corrective action: the U. S. primary surplus is an increasing function of the debt-GDP ratio. The debt-GDP ratio displays mean-reversion if one controls for war-time spending and for cyclical fluctuations. The positive response of the primary surplus to changes in debt also shows that U. S. fiscal policy is satisfying an intertemporal budget constraint.

The Sustainability of Budget Deficits in a Stochastic Economy

The transversality condition on government debt requires a zero limit of discounted future debt. The paper shows that, in a stochastic economy, the relevant discount rate depends on the probability distribution of future debt over states of nature. Discount rates on future government debt, spending, and taxes are generally not related to the rates of return on government debt. The correct choice of discount rates is important because debt discounted at the safe interest rate may well diverge to infinity under sustainable policies. This result raises questions about some recent empirical papers testing the sustainability of U.S. fiscal policy. Copyright 1995 by Ohio State University Press.

Budget Balance Through Revenue or Spending Adjustments? Some Historical Evidence for the United States

Abstract The paper provides a historical perspective on the issue of whether budget deficits are typically eliminated by increased taxes or by reduced spending. By examining U.S. budget data from 1792–1988, I conclude that about 50–65% of all deficits due to tax cuts and about 65–70% of all deficits due to higher government spending have been eliminated by subsequent spending cuts, while the remainder was eliminated by subsequent tax increases. In contrast to previous studies, the empirical analysis uses error-correction models in a way that the intertemporal budget constraint is imposed in the estimation stage.

Why do we have nominal government debt

Abstract We study the choice between nominal and indexed debt in a stochastic macroeconomic model with discretionary monetary and fiscal policy. With distortionary taxes, nominal debt provides valuable insurance against the budgetary effects of economic fluctuations. We show that a welfare-maximizing government always issues some nominal debt even though nominal debt increases inflation along the time-consistent path of the economy. The result is fairly robust with respect to changes in assumptions about policy constraints and about the macroeconomic setting.

Alternative Nonnested Specification Tests of Time Series Investment Models

This paper develops and compares nonnested hypothesis tests for linear regression models with first-order serially correlated errors. It extends the nonnested testing procedures of Pesaran, Fisher and McAleer, and Davidson and MacKinnon, and compares their performance on four conventional models of aggregate investment demand using quarterly U.S. investment data from 1951:1 to 1983:IV. The data and the nonnested hypothesis tests initially indicate that no model is correctly specified, and that the tests are occasionally intransitive in their assessments. Before rejecting these conventional models of investment demand, we go on to investigate the small sample properties of these different nonnested test procedures through a series of monte carlo studies. These investigations demonstrate that when there is significant serial correlation, there are systematic finite sample biases in the nominal size and power of these test statistics. The direction of the bias is toward rejection of the null model, although it varies considerably by the type of test and estimation technique. After revising our critical levels for this finite sample bias, we conclude that the accelerator model of equipment investment cannot be rejected by any of the other alternatives.

Will social security and Medicare remain viable as the U.S. population is aging

Abstract Yes, subject to concerns about Medicare cost and potentially self-confirming skepticism. The U.S. social security system (broadly defined, including Medicare) faces significant financial problems as the result of an aging population. But demographic change is also likely to raise savings, increase wages, and reduce interest rates. Viewed in this context, the fiscal problems of retirement insurance seem over-rated. A more serious issue is the rapid growth of Medicare spending. Up to a point, a growing GDP-share of medical spending is an efficient response to an aging population. But Medicare growth might be excessive due to moral hazard problems. Except for this caveat, social security is almost certainly economically viable. To examine the political viability of social security, I focus on intertemporal cost-benefit tradeoffs in a median-voter setting. For a variety of assumptions, I find that social security will retain majority support. I also discuss the role of altruism, redistribution, and multi-dimensional voting and find that they provide additional voter support for social security.

A positive theory of foreign currency debt

Abstract This paper makes a case for foreign currency debt as a hedging device in an open economy subject to stochastic shocks to output. A government can reduce uncertainty in wealth and in consumption by issuing foreign or domestic currency debt if unexpected domestic and foreign inflation are negatively correlated with domestic output. Foreign currency debt is desirable in comparison to domestic currency debt if growth rates of output of both countries are closely related and if domestic inflation is relatively uncertain. It has an additional advantage if domestic debt creates time-consistency problems.

Budget deficits and government accounting

Abstract The paper examines the measurement of government debts and budget deficits. The main theoretical finding is that accrual-based government accounts are well-defined and economically relevant, provided taxation is distortionary on the margin. The empirical section derives U.S. government balance sheets and income statements for 1947–1989. For 1989, U.S. government net debt is about

The sustainability of budget deficits with lump-sum and with income-based taxation

3380 billion; government net worth is about -

Retirement Savings in an Aging Society: A Case for Innovative Government Debt Management

1680 billion. This includes unfunded government employee pensions but not the social-security system. I argue that social security creates a separate class of government obligations that are enforced by political rather than contractual, market-based mechanisms.