Fiscal Capacity: An Asset Pricing Perspective

Zhengyang Jiang, Hanno Lustig, Stijn Van Nieuwerburgh and Mindy Z. Xiaolan
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Zhengyang Jiang: Finance Department, Kellogg School of Management, Northwestern University, Evanston, Illinois, USA
Hanno Lustig: National Bureau of Economic Research, Cambridge, Massachusetts, USA
Mindy Z. Xiaolan: McCombs School of Business, The University of Texas at Austin, Austin, Texas, USA

Annual Review of Financial Economics, 2023, vol. 15, issue 1, 197-219

Abstract: This review revisits the literature on fiscal capacity using modern tools from asset pricing. We find that properly accounting for aggregate risk substantially reduces fiscal capacity. In this environment, the gap between the risk-free rate and the expected growth rate is not a sufficient statistic for fiscal capacity. To borrow at the risk-free rate when aggregate growth is risky, governments need to ask taxpayers to insure bondholders against aggregate risk, but governments in advanced economies tend to insure taxpayers against aggregate risk. We use this asset pricing perspective to review alternative mechanisms to boost fiscal capacity that have been explored in the literature.

Keywords: fiscal policy; term structure; debt maturity; convenience yield (search for similar items in EconPapers)
JEL-codes: E62 G12 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1146/annurev-financial-110921-103651

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