What Drives Variation in the U.S. Debt/Output Ratio? The Dogs that Didn't Bark

Abstract

A higher U.S. government debt/output ratio does not forecast higher surpluses or lower returns
on Treasurys in the future. Neither future cash flows nor discount rates account for the
variation in the current debt/output ratio. The market valuation of Treasurys is surprisingly
insensitive to the macro fundamentals. Instead, the future debt/output ratio accounts for most
of the variation because the debt/output ratio is highly persistent. Systematic surplus forecast
errors may help to account for these findings. Since the start of the GFC, surplus projections
have anticipated a large fiscal correction that failed to materialize.

Keywords: fiscal policy, bond pricing.

JEL Classification: G12, E62