Federal Debt, Tax-Adjusted q, and Macroeconomic Activity: Note

Abstract

1. lntroduction Although the role of government debt in the macroeconomy has been intensively analyzed in recent years, there appears to be no theoretical or empirical consensus regarding the impact of government debt on the macroeconomy. The focus of much of this research has been the validity of the Ricardian equivalence hypothesis, and empirical studies have frequently analyzed the impact of government debt on a particular variable like the interest rate, consumption, or output within a singleequation framework. 1 However, since the question of whether government debt is net wealth clearly has implications for a wide range of macroeconomic variables, it would seem appropriate to analyze empirically the effects of government debt within a small macroeconomic model. This is the aim of this study. The framework for the analysis is a ten-variable vector autoregressive (VAR) model, and the effects of federal debt are analyzed through the computation of variance decompositions and impulse response functions.2 This study is distinguished from others by its more comprehensive specification of the financial sector of the model and by the use of a Monte Carlo simulation technique to estimate standard errors for the variance decompositions and impulse response functions. This allows an assessment of the significance of the effects of federal debt on the macroeconomy.