The Public Debt Crisis of the United States. (16th July 2017)

• Record Type: Journal Article
• Authors: Mendoza, Enrique G.
• Is Part Of: Manchester school. Volume 85(2017)Supplement 1
• Page Start: 1
• Page End: 32
• Publication Date: 2017-07-16
• Subjects: Economics -- Periodicals; Social sciences -- Periodicals; Economics -- Sociological aspects -- Periodicals; 330.05
• DOI: 10.1111/manc.12193
• Languages: English
• ISSNs: 1463-6786

Abstract

Abstract : Since the birth of the Republic, the United States has gone through five debt‐crisis episodes defined as year‐on‐year increases in net federal debt in the 95‐percentile. The Great Recession is the second largest, and the only one in which primary deficits continue six years later and are expected to persist at least through 2026. Persistent deficits are also sharply at odds with the surpluses that contributed to the reversal of all major debt surges in U.S. history. There is a view that high debt is not a concern and more debt is needed for fiscal stimulus and/or strong global demand for 'safe assets'. This paper makes four points to the contrary based on findings from the literature: First, empirical work shows that debt sustainability conditions display a significant break after 2008 and fiscal stimulus fails when debt is high. Second, a dynamic general equilibrium model predicts that tax adjustments may not make the debt sustainable and will have adverse effects on macro aggregates and social welfare. Third, the strong appetite for U.S. public debt worldwide can be a slow‐moving, transitory result from financial globalization in an environment in which U.S. financial markets are relatively more developed and the expected financing needs of the U.S. government are large. Fourth, domestic sovereign default could become optimal if the cost of regressive redistribution in order to make debt payments outweighs default costs related to the social value of debt for liquidity provision, self‐insurance and risk‐sharing.