THE BEHAVIOR OF U.S. PUBLIC DEBT AND DEFICITS DURING THE GLOBAL FINANCIAL CRISIS

In this paper we test the sustainability of U.S. public debt for the period 1916–2012 by analyzing how the primary surplus to gross domestic product (GDP) responds to changes in the debt to GDP ratio in a time-varying parameter model. Further, we determine the stationarity property of the debt/GDP ratio while accommodating possible breaks in the data caused by wars and economic crisis under both the null and alternative hypotheses of an endogenous unit root test. The results show that the U.S. public debt was sustainable until 2005 when the primary surplus to GDP reacted negatively to the debt/income ratio. This is further exacerbated during the global financial crisis when primary surpluses continued to fall with increased debt, thus jeopardizing the sustainability of fiscal policy. While the stationarity test shows that the U.S. fiscal debt/GDP ratio is sustainable, it fails to highlight the risk that its debt policy has been becoming unsustainable in recent years. (JEL H62, E62, C2).