RDP 8809: The Intertemporal Government Budget Constraint and Tests for Bubbles 5. Conclusion

The purpose of this paper has been to examine the sustainability of government debt over the period 1953/54 to 1986/87. To explore this question, we have used two tests adapted from the literature on ‘bubbles’. Our study has generalised the previous approaches to allow for the effects of income growth and demonstrates that the methods of Trehan and Walsh (1988) and previous practitioners, based on cointegration, are the same under certain conditions.

The finding that the two series, government spending and taxation plus seignorage, are cointegrated with a cointegrating coefficient of unity leads us to accept that governments have not attempted to pursue unsustainable fiscal deficits for any lengthy period between 1953 and 1987. In other words we cannot consider the historical level of government debt to be at levels which are unsustainable.

An important implication of the cointegration results is that we cannot reject the hypothesis that governments have used seignorage to finance primary deficits. Evidence from our second test indicates that this has played a significant role in reducing the real value of government debt up until recently. This is compatible with the hypothesis that seignorage rather than debt financing has been the residual for financing fiscal deficits.