Where is U.S. Sovereign Debt Heading? A Forecasting Model

Abstract

We develop a debt-to-GDP forecasting framework incorporating the classical debt accounting relationship relating the debt-to-GDP ratio to its previous period value, the growth rate of the economy, the government cost of debt service, and the primary balance. We present a linearization of the debt buildup equation, and a parsimonious model of the evolution of the government borrowing costs and the primary balance dynamics. We apply our framework to the U.S. economy described by an unrestricted Vector Auto-Regression (VAR), and forecast the multi-year path of the federal debt load from 2010 onwards. We find that our forecasts are in good agreement with realized values of debt-to-GDP across 2010, 2011 and 2012. We also perform a scenario analysis under different assumptions for the persistence of the budget balance, and show that President Obama's 2009 budget projection was less realistic than one based on a historically observed persistence.