How does the U.S. government finance fiscal shocks?

Abstract

We develop a method for identifying and quantifying the fiscal channels that help finance government spending shocks and apply it to postwar U.S. data. We define fiscal shocks as surprises in defense spending and show that they are more precisely identified when defense stock data are used in addition to aggregate macroeconomic data. Our results show that in the postwar period, over 9 % of the U.S. government’s unanticipated spending needs were financed by a reduction in the market value of debt and more than 73 % by an increase in primary surpluses. We provide evidence that longer maturity debt is more effective at absorbing fiscal risk and discuss the implications of this result for active management of public debt.

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