The Congressional Budget Office’s Long-Term Budget Outlook forecasts federal debt held by the public to rise to about 200 percent of GDP by 2050. Such a large increase raises the possibility that the federal government may default on a portion of its debt. This paper uses a non-linear DSGE model to estimate the effective debt limit — the debt level at which the federal government would default on part of its obligations.
Common Credit Cycles and Business Cycles in the United States
This paper investigates the co-movement of debt and real activity over the business cycle. It estimates vector autoregressions (VAR) that are subject to common trends and common cycles restrictions. The estimated models are then used to compute a permanent-transitory decomposition of macro and financial aggregates. The shocks to the permanent component constitute a significant portion of the total changes in the debt-to-assets ratio. The effects of the shocks to the permanent component are an important feature that models of the business cycle with collateral constraints need to incorporate.
Production-Based Asset Pricing in a Real Business Cycle Model with Endogenous Liquidity
Recent literature investigating liquidity shocks in real business cycle models has had difficulty reproducing the behavior of asset prices over the business cycle. This paper builds a real business cycle model in which liquidity is endogenously determined. In the model, the existence of a collateral constraint is motivated by limited enforcement of contracts. Changes in liquidity are related to the risk that a borrower fails to repay a loan. The paper describes the transmission mechanisms generated by endogenizing liquidity and quantifies the effect on business cycle moments and asset prices. The results suggest that endogenous liquidity improves the asset pricing moments of the model, but that changes in liquidity have little effect on other business cycle moments.