Persistent Deficits and the Market Value of Government Debt

Gregor Smith and Stanley Zin

Journal of Applied Econometrics, 1991, vol. 6, issue 1, 31-44

Abstract: This paper investigates whether postwar Canadian public financial policy satisfies a borrowing constraint. Direct tests of the present-value relation suggested by this constraint shed light on the sustainability of current policy. We examine monthly data on Canadian federal government finances using tests for cointegration. The finding is that the joint behavior of real debt and real surpluses is inconsistent with intertemporal budget balance for the government. One interpretation of this finding is that the government is systematically paying real returns to bondholders by issuing further debt. Alternatively, bondholders may expect the government to finance future interest payments from a source other than primary surpluses, e.g. the sale of physical assets. Copyright 1991 by John Wiley & Sons, Ltd.

Date: 1991
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