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"Debt and Deficits: Fiscal Analysis with Stationary Ratios"

Abstract: We introduce a new measure of a government's  fiscal position that exploits cointegrating relationships among fiscal variables and output. The measure is a loglinear combination of tax revenue, government spending and the market value of government debt that|unlike the debt-GDP ratio-appears stationary in the US and 15 other developed countries. A weak fiscal position must ultimately be resolved by low future returns on government debt or by  fiscal adjustment, a combination of high tax growth and low spending growth. Empirically, we find that debt returns play a negligible role and that fiscal adjustment predominantly consists of changes in spending growth. We also study shocks to taxes and spend- ing, finding negligible responses of debt returns to these shocks which are instead associated with subsequent mean-reversion in tax and spending growth.

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