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The Dow and Government-Granted Patent Monopolies

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One of the recurring items in the news that infuriates progressives and fans of economic logic everywhere is discussions of the stock market that treat it as a measure of economic well-being. Donald Trump carries this to an extreme, with seemingly no understanding that there are other important economic measures, but he is hardly alone. In fact, many economic commentators seem hard-pressed to explain the continued strength of the stock market, when most projections show the unemployment rate remaining extraordinarily high for the foreseeable future.

The reason why this is infuriating is that there is no direct link between the growth in the stock market and the health of the economy. This is not a leftist criticism of the evils of capitalism, it is the Finance 101 explanation of stock prices.

The stock market is supposed to reflect the present value of future after-tax corporate profits. (“Present value” means that we apply a discount rate so that profits anticipated five or ten years out are considered to be of less value than profits expected next month.) This means that events in the world that are likely to lead to higher future profits should raise stock prices, regardless of whether or not they are good for the economy as a whole.

This could mean that the stock market will rise when the economy is strong, since other things equal, a stronger economy is likely to mean higher corporate profits. But, the stock market could rise simply because corporate profits are expected to increase at the expense of everyone else’s income.

Just to take an example from recent policy changes, a big cut in the corporate income tax should lead to higher stock prices, since it should mean higher after-tax profits. There is little reason to believe that a cut in corporate income taxes would have a substantial effect in boosting growth (it didn’t), but since after-tax profits will be higher as a result of the tax cut, the stock market should also be higher.

The stock market does generally track the economy for the simple reason that stronger growth will usually mean higher profits, but this is hardly a tight connection. The price of corn will generally track the overall economy too since stronger growth will be mean more demand for corn, but no one in their right mind would treat the price of corn as an indicator of economic well-being.

So why do people insist on treating the stock market as a measure of economic well-being when it clearly is not?  That probably is attributable to the people who benefit from a rising stock market. That would be the people who own lots of stock, in other words, rich people. Rich people are also the ones who own and control major news outlets. For this reason, they are not bothered when people writing news stories or columns say that the stock market is a measure of economic well-being, as opposed to being a measure of how much money rich people have.

To be clear, I doubt anyone in an ownership position at a newspaper or broadcast or Internet outlet ever told a reporter or columnist to write a piece saying that the stock market is a measure of economic well-being. Rather, this is one of those wrong things that a reporter or columnist can say over and over again and never be called on the carpet for it. By contrast, if a reporter tried to tell their audience that the price of corn is a measure of economic well-being, they would probably have some serious explaining to do to their editor and other higher-ups. If they continued to assert that the price of corn was a measure of economic well-being, they would probably be looking for a new job.

The point here is that power has a large influence on what arguments appear in news outlets. Because people with money benefit from higher stock prices, we are likely to continue to see the claim that stock prices are a measure of economic well-being long into the future, even though it is not true.

 

Power and Government-Granted Patent Monopolies

The story of the stock market as a measure of economic well-being is important to keep in mind when we consider the media’s decision to almost completely ignore the issue of patent and copyright monopolies as government policies that redistribute income upward.  Just as the myth of the stock market metric of well-being is perpetuated because of who it benefits, the analysis of patents and copyrights as policies leading to upward redistribution is not ever mentioned because of who would potentially be harmed.

In the case of patent and copyright monopolies, the beneficiaries go beyond the relatively small group of people who own large amounts of stock in pharmaceutical companies, medical equipment manufacturers, or software developers. It includes the bulk of the highly educated workforce, including the people who edit, write, and report for major news outlets. Even if many of these people are not especially highly paid, they almost certainly have friends and relatives who benefit from patent and copyright monopolies. 

There is a very widespread belief that trends in technology and globalization are major factors in the upward redistribution of income over the last four decades. The basic story is that developments in computers, biotechnology, and other areas have hugely increased the value of education (especially in the STEM fields) and reduce the value of unskilled (their term) manual labor. Many people who consider themselves quite progressive hold this view. They just feel that they should give back some of their good fortune by paying higher taxes to benefit the less fortunate.

However, if it is acknowledged that it is government policy, specifically patent and copyright monopolies, that is behind this upward redistribution, and not technology or globalization, then it means inequality was the result of deliberate policy, not the natural workings of the market.[1] This is a much less flattering view, both for those who want to keep the benefits from this upward redistribution and even for those progressives who would willingly pay higher taxes.

For this reason, the argument that upward redistribution was the result of deliberate policy, is not one that is welcome in most media outlets, including progressive ones. The idea that patents and copyrights are simply facts of nature persists, even though it is obviously absurd on its face.

It is unfortunate that power relations preclude serious debate on an issue that is so central to reducing inequality. But it is important to recognize the obstacles to having this debate if we are ever to overcome them.

[1] I have made this argument in a number of different places, for example here, here, and here. But to illustrate the issue as simply as possible, consider a world where there are no patent or copyright monopolies. How many people would be paid to research new drugs and develop new medical equipment in a context where any manufacturers could immediately copy anything developed and sell it at a price that would recoup manufacturing costs and a normal profit? How many people would be paid to design software for computers, smartphones, and other products if anyone could immediately copy the software without sending the developer a dime? While these are valuable services, how many people are employed doing them, and how much they get paid are quite clearly the result of policy decisions, not the technology itself.  

The post The Dow and Government-Granted Patent Monopolies appeared first on Center for Economic and Policy Research.



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Economy

Newsletter: The Recovery Is Losing Momentum

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This is the web version of the WSJ’s newsletter on the economy. You can sign up for daily delivery here.

Slow Ride

The nation’s fledgling economic recovery is losing momentum, as a new wave of coronavirus infections causes businesses to scale back or reshutter in several big states and consumers to retreat anew. Restaurant seating rates have fallen of late in Florida, California, Arizona and Texas. Foot traffic to businesses has ebbed in some states since late June. Google searches for “file for unemployment” in Arizona and Florida are rising. The new economic disruptions are concentrated in the three most populous states—California, Texas and Florida—and Arizona, all of which have seen a rise in infections in recent weeks. Together, those states make up about 30% of all U.S. economic output, Sarah Chaney, Gwynn Guilford and Josh Mitchell report.

Many economists still believe the economy is growing again after a sharp contraction in the spring caused by the pandemic. But some have lowered their expectations in recent days, suggesting the shape of the recovery will be jagged rather than a V signifying a sharp drop in activity followed by a similarly sharp rebound.

WHAT TO WATCH TODAY

U.S. jobless claims in the week ended July 4 are expected to fall to 1.388 million from 1.427 million a week earlier. (8:30 a.m. ET)

U.S. wholesale inventories for May are expected to fall 1.2% from a month earlier. (10 a.m. ET)

The WSJ’s survey of economists is out at 10 a.m. ET.

Atlanta Fed President Raphael Bostic speaks to the Tax Policy Center at 12 p.m. ET.

TOP STORIES

Out of Work

The number of workers seeking new unemployment benefits has plateaued at a historically high level, showing that many Americans are still losing their jobs even as broad swathes of the labor market heal. Weekly jobless benefit applications, historically a proxy for layoffs, have held between 1 million and 2 million since late May, and economists expect the figure will remain in that range again for the week ended July 4, Eric Morath and Kim Mackrael report.

When Congress passed the Cares Act, it accomplished something never before achieved in the U.S.: It roughly matched the number of people receiving unemployment benefits with the number counted as unemployed. The historical comparison isn’t perfect: Some of those on unemployment might not be unemployed by the Bureau of Labor Statistics definition, and some who are unemployed may still not be receiving benefits for a variety of reasons. But the law is one reason incomes jumped in April and  likely supported a surge in consumer spending in May. 

United Airlines said it is exploring the possibility of shedding almost half its U.S. workforce, the first major domestic carrier to detail how deep the industry might have to retrench amid the pandemic-driven slump in passenger demand. The Chicago-based carrier is sending mandatory 60-day notices under federal labor rules to 36,000 of its employees, a week after American Airlines said it may have as many as 20,000 more staff than it needs to handle reduced demand. The U.S. airline industry is facing its biggest shake-up in a generation, with executives expecting a recovery in the demand slump to take years, Doug Cameron and Alison Sider report.

Companies don’t expect to return to prepandemic employment levels this year—or next. A survey conducted by Duke University and the Richmond and Atlanta Feds found CFOs more optimistic about their own businesses but fairly pessimistic about the path for employment growth. “In fact, the typical firm in our panel does not expect to regain their pre-Covid employment levels until sometime after the end of 2021,” Atlanta Fed economists wrote in a summary of the CFO survey.

How Much Is All This Going to Cost?

The U.S. budget deficit totaled $863 billion in June, nearly as much as the entire gap for fiscal year 2019, the Congressional Budget Office said Wednesday. Federal spending tripled to combat the coronavirus pandemic and tax revenues plunged, Kate Davidson reports.

The U.K. government announced up to $38 billion in fresh stimulus measures intended to boost the country’s economy as it exits lockdown. Since measures designed to contain the novel coronavirus became widespread in March, governments around the world have committed trillions of dollars to ensuring the survival of businesses and to supporting household incomes. The U.K.’s new package marks the start of a second phase of government spending and tax cuts designed to boost demand and give businesses the confidence to put their employees back to work, Paul Hannon reports.

Trade Trouble

President Trump’s trade war with China is meeting at least one of his goals. The U.S. trade deficit with China in the past 12 months has dropped to its lowest since 2012. Unfortunately, that narrowing has come from the U.S. buying less from China, rather than China buying more from the U.S. Slack Chinese imports are a symptom of the underlying reason China’s trade surpluses, not just with the U.S. but the world, persist: China consumes too little and saves too much. Consumption is still under 40% of Chinese GDP, one of the lowest ratios among major economies. That imbalance is why trade conflicts aren’t about to go away even if Mr. Trump isn’t re-elected, Greg Ip reports.

WHAT ELSE WE’RE READING

Want to move to a big city but don’t have a college degree? Career opportunities are drying up, have been for decades and the Covid-19 pandemic will probably make it worse. “While cities remain vibrant for workers with college degrees, the urban skills and earnings escalator for non-college workers has lost its ability to lift workers up the income ladder. Measured by occupational structures and real wage levels, urban opportunities for non-college workers have deteriorated swiftly and pervasively relative to non-urban labor markets,” MIT’s David Autor writes in a new research brief.

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Economy

Reclaiming freedom

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We might be seeing a significant political change, with the left reclaiming freedom and anti-statism from the right.

I'm prompted to say this by the Black Lives Matter slogan, "defund the police" which invites us to see the state as an oppressor. As Grace Blakeley recently tweeted:

People know that the state is fucking them over just as much as their boss or landlord – in fact, it’s helping their boss and landlord fuck them over even more…Rather than saying ‘just give more state power to the goodies (us)’ we need to start saying ‘put power where it belongs – in the hands of working people’.

If we read this alongside the disappearance of right-libertarians (some of whom discovered that they like racism and inequality more than small government) and emergence of big government Toryism, we see a big change from a few years ago. Back then, it was the right who called for a smaller state and much of the left that wanted a bigger one. Now it is, if anything, the opposite*.

In one sense this is a return to normality. Historically, advocates of freedom were opponents of the existing order, such as Tom Paine, John Stuart Mill and – yes – Adam Smith**. And, of course, Marxists have long regarded the state as "a committee for managing the common affairs of the whole bourgeoisie" and looked forward to it withering away.

Which poses the question: why are things now changing (back)?

One reason is that the left has learned that states are indeed often repressive. I'm thinking here not just of police killings but of the social murder that is austerity and tough benefit sanctions, and the forced deportations of black Britons (something still going on).

Secondly, they've learned that, as Grace says, it is not good enough to "give more state power to the goodies". Yes, New Labour did make significant achievements in tax credits, Sure Start and better funding of schools and the NHS. But many of these have been reversed by the Tories in the subsequent decade. The left cannot pin its hopes merely on winning temporary (and partial) control of the state.

Thirdly, changes within capitalism have changed the state. Of course, capital (pdf) has always wielded power over governments. But there was a time when this was relatively benign. In the post-war war mass production Fordist capitalists needed a mass market and hence an affluent working class. Extractive finance capital, though, doesn't. It needs cheap and plentiful money which fiscal austerity helps provide. General Motors needed a large well-paid working class; Goldman Sachs, not so much. This means there is now more tension between the needs of working people and the function of the state than there used to be.

All of which poses the question. What would anti-statist leftism look like?

Many of you might think the slogan "defund the police" goes too far. No matter: we don't know what's right unless we know what's too much. And what is right – as Elinor Ostrom showed – is that the police should be small and locally accountable. Also, there's a strong case for decriminalizing drugs, in part because it removes a pretext for the police to harass black people.

A high universal basic income would also expand freedom, not just by removing the harsh conditionality of Universal Credit, but also by giving us the freedom to reject exploitative labour or to drop out of the labour market to care for others or to train for better work. As Guy Standing says (pdf), "basic Income’s emancipatory value exceeds its monetary value."

Also, left-libertarianism must empower local communities, and embrace the community wealth-building advocated by Martin O'Neil and Joe Guinan and pioneered by Preston council. In weakening the power of central government, localization mitigates the damage done by Tory austerity. And it also gives local people more republican freedom – the freedom to collectively control more of their own lives.

There's something else, which the Black Lives Matter movement is also highlighting. It's that slavery teaches us something about economics. As Peter Doyle shows in a brilliant paper (pdf), markets produce incentives to undermine others' agency. Although slavery is the most extreme example of this we also see it in everyday capitalist labour markets. As Marx said, when we they start work workers leave behind the realm of equality and freedom and become mere factors of production. Left-libertarianism would put in place institutions to resist this and expand the realm of genuine agency. This would comprise worker coops and more local say over public services.

I say all this not to offer detailed blueprints: Marx was right to be sceptical of these. Instead, the point is that the left can and should pick up the cause of freedom now that the right has abandoned it.

* We mustn't be misled by the right's loud assertion of a right to free speech. What they are really proclaiming is the "right" to spout rubbish without any comeback, which is an altogether different matter.

** If you think the Adam Smith Institute is a representative guide to Smith's thinking, the wallet inspectors would like to meet you.



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Economy

The Surplus Process

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How should we model surpluses and deficits? In finishing up a recent articleand chapter 5 and 6 of a Fiscal Theory of the Price Level update, a bunch of observations coalesced that are worth passing on in blog post form.

Background: The real value of nominal government debt equals the present value of real primary surpluses, [ frac{B_{t-1}}{P_{t}}=b_{t}=E_{t}sum_{j=0}^{infty}beta^{j}s_{t+j}. ] I ‘m going to use one-period nominal debt and a constant discount rate for simplicity. In the fiscal theory of the price level, the (B) and (s) decisions cause inflation (P). In other theories, the Fed is in charge of (P), and (s) adjusts passively. This distinction does not matter for this discussion. This equation and all the issues in this blog post hold in both fiscal and standard theories.

The question is, what is a reasonable time-series process for (left{s_{t}right} ) consistent with the debt valuation formula? Here are surpluses

The blue line is the NIPA surplus/GDP ratio. The red line is my preferred measure of primary surplus/GDP, and the green line is the NIPA primary surplus/GDP.

The surplus process is persistent and strongly procyclical, strongly correlated with the unemployment rate.  (The picture is debt to GDP and surplus to GDP ratios, but the same present value identity holds with small modifications so for a blog post I won’t add extra notation.)

Something like an AR(1) quickly springs to mind, [ s_{t+1}=rho_{s}s_{t}+varepsilon_{t+1}. ] The main point of this blog post is that this is a terrible, though common, specification.

Write a general MA process, [ s_{t}=a(L)varepsilon_{t}. ] The question is, what’s a reasonable (a(L)?) To that end, look at the innovation version of the present value equation, [ frac{B_{t-1}}{P_{t-1}}Delta E_{t}left( frac{P_{t-1}}{P_{t}}right) =Delta E_{t}sum_{j=0}^{infty}beta^{j}s_{t+j}=sum_{j=0}^{infty}beta ^{j}a_{j}varepsilon_{t}=a(beta)varepsilon_{t}% ] where [ Delta E_{t}=E_{t}-E_{t-1}. ] The weighted some of moving average coefficients (a(beta)) controls the relationship between unexpected inflation and surplus shocks. If (a(beta)) is large, then small surplus shocks correspond to a lot of inflation and vice versa. For the AR(1), (a(beta)=1/(1-rho_{s}beta)approx 2.) Unexpected inflation is twice as volatile as unexpected surplus/deficits.

(a(beta)) captures how much of a deficit is repaid. Consider (a(beta)=0). Since (a_{0}=1), this means that the moving average is s-shaped. For any (a(beta)lt 1), the moving average coefficients must eventually change sign. (a(beta)=0) is the case that all debts are repaid. If (varepsilon_{t}=-1), then eventually surpluses rise to pay off the initial debt, and there is no change to the discounted sum of surpluses. Your debt obeys (a(beta)=0) if you do not default. If you borrow money to buy a house, you have deficits today, but then a string of positive surpluses which pay off the debt with interest.

The MA(1) is a good simple example, [ s_{t}=varepsilon_{t}+thetavarepsilon_{t-1}% ] Here (a(beta)=1+thetabeta). For (a(beta)=0), you need (theta=-beta ^{-1}=-R). The debt -(varepsilon_{t}) is repaid with interest (R).

Let’s look at an estimate. I ran a VAR of surplus and value of debt (v), and I also ran an AR(1).

Here are the response functions to a deficit shock:

The blue solid line with (s=-0.31) comes from a larger VAR, not shown here. The dashed line comes from the two variable VAR, and the line with triangles comes from the AR(1).

The VAR (dashed line) shows a slight s shape. The moving average coefficients gently turn positive. But when you add it up, those overshootings bring us back to (a(beta)=0.26) despite 5 years of negative responses. (I use (beta=1)). The AR(1) version without debt has (a(beta)=2.21), a factor of 10 larger!

Clearly, whether you include debt in a VAR and find a slightly overshooting moving average, or leave debt out of the VAR and find something like an AR(1) makes a major difference. Which is right? Just as obviously, looking at (R^2)   and t-statistics of the one-step ahead regressions is not going to sort this out.

I now get to the point.

Here are 7 related observations that I think collectively push us to the view that (a(beta)) should be a quite small number. The observations use this very simple model with one period debt and a constant discount rate, but the size and magnitude of the puzzles are so strong that even I don’t think time-varying discount rates can overturn them. If so, well, all the more power to the time-varying discount rate! Again, these observations hold equally for active or passive fiscal policy. This is not about FTPL, at least directly.

1) The correlation of deficits and inflation. Reminder, [ frac{B_{t-1}}{P_{t-1}}Delta E_{t}left( frac{P_{t-1}}{P_{t}}right) =a(beta)varepsilon_{t}. ] If we have an AR(1), (a(beta)=1/(1-rho_{s}beta)approx2), and with (sigma(varepsilon)approx5%) in my little VAR, the AR(1) produces 10% inflation in response to a 1 standard deviation deficit shock. We should see 10% unanticipated inflation in recessions! We see if anything slightly less inflation in recessions, and little correlation of inflation with deficits overall. (a(beta)) near zero solves that puzzle.

2) Inflation volatility. The AR(1) likewise predicts that unexpected inflation has about 10% volatility. Unexpected inflation has about 1% volatility. This observation on its own suggests (a(beta)) no larger than 0.2.

3) Bond return volatility and cyclical correlation. The one-year treasury bill is (so far) completely safe in nominal terms. Thus the volatility and cyclical correlation of unexpected inflation is also the volatility and cyclical correlation of real treasury bill returns. The AR(1) predicts that one-year bonds have a standard deviation of returns around 10%, and they lose in recessions, when the AR(1) predicts a big inflation. In fact one-year treasury bills have no more than 1% standard deviation, and do better in recessions.

4) Mean bond returns. In the AR(1) model, bonds have a stock-like volatility and move procyclically. They should have a stock-like mean return and risk premium. In fact, bonds have low volatility and have if anything a negative cyclical beta so yield if anything less than the risk free rate. A small  (a(beta)) generates low bond mean returns as well.

Jiang, Lustig, Van Nieuwerburgh and Xiaolan recently raised this puzzle, using a VAR estimate of the surplus process that generates a high (a(beta)). Looking at the valuation formula [ frac{B_{t-1}}{P_{t}}=E_{t}sum_{j=0}^{infty}beta^{j}s_{t+j}, ] since surpluses are procyclical, volatile, and serially correlated like dividends, shouldn’t surpluses generate a stock-like mean return? But surpluses are crucially different from dividends because debt is not equity. A low surplus (s_{t}) raises  our estimate of subsequent surpluses (s_{t+j}). If we separate out
 [b_{t}=s_{t}+E_{t}sum_{j=1}^{infty}beta^{j}s_{t+j}=s_{t}+beta E_{t}b_{t+1}  ] a decline in the “cashflow” (s_{t}) raises the “price” term (b_{t+1}), so the overall return is risk free. Bad cashflow news lowers stock pries, so both cashflow and price terms move in the same direction. In sum a small (a(beta)lt 1) resolves the Jiang et. al. puzzle. (Disclosure, I wrote them about this months ago, so this view is not a surprise. They disagree.)

5) Surpluses and debt. Looking at that last equation, with a positively correlated surplus process (a(beta)>1), as in the AR(1), a surplus today leads to  larger value of the debt tomorrow. A deficit today leads to lower value of the debt tomorrow. The data scream the opposite pattern. Higher deficits raise the value of debt, higher surpluses pay down that debt. Cumby_Canzoneri_Diba (AER 2001) pointed this out 20 years ago and how it indicates an s-shaped surplus process.  An (a(beta)lt 1) solves their puzzle as well. (They viewed (a(beta)lt 1) as inconsistent with fiscal theory which is not the case.)

6) Financing deficits. With (a(beta)geq1), the government finances all of each deficit by inflating away outstanding debt, and more. With (a(beta)=0), the government finances deficits by selling debt. This statement just adds up what’s missing from the last one. If a deficit leads to lower value of the subsequent debt, how did the government finance the deficit? It has to be by inflating away outstanding debt. To see this, look again at inflation, which I write [ frac{B_{t-1}}{P_{t-1}}Delta E_{t}left( frac{P_{t-1}}{P_{t}}right) =Delta E_{t}s_{t}+Delta E_{t}sum_{j=1}^{infty}beta^{j}s_{t+j}=Delta E_{t}s_{t}+Delta E_{t}beta b_{t+1}=1+left[ a(beta)-1right] varepsilon_{t}. ] If (Delta E_{t}s_{t}=varepsilon_{t}) is negative — a deficit — where does that come from? With (a(beta)>1), the second term is also negative. So the deficit, and more, comes from a big inflation on the left hand side, inflating away outstanding debt. If (a(beta)=0), there is no inflation, and the second term on the right side is positive — the deficit is financed by selling additional debt. The data scream this pattern as well.

7) And, perhaps most of all, when the government sells debt, it raises revenue by so doing. How is that possible? Only if investors think that higher surpluses will eventually pay off that debt. Investors think the surplus process is s-shaped.

All of these phenomena are tied together.  You can’t fix one without the others. If you want to fix the mean government bond return by, say, alluding to a liquidity premium for government bonds, you still have a model that predicts tremendously volatile and procyclical bond returns, volatile and countercyclical inflation, deficits financed by inflating away debt, and deficits that lead to lower values of subsequent debt.

So, I think the VAR gives the right sort of estimate. You can quibble with any estimate, but the overall view of the world required for any estimate that produces a large (a(beta)) seems so thoroughly counterfactual it’s beyond rescue. The US has persuaded investors, so far, that when it issues debt it will mostly repay that debt and not inflate it all away.

Yes, a moving average that overshoots is a little unusual. But that’s what we should expect from debt. Borrow today, pay back tomorrow. Finding the opposite, something like the AR(1), would be truly amazing. And in retrospect, amazing that so many papers (including my own) write this down. Well, clarity only comes in hindsight after a lot of hard work and puzzles.

In more general settings (a(beta)) above zero gives a little bit of inflation from fiscal shocks, but there are also time-varying discount rates and long term debt in the present value formula. I leave all that to the book and papers.

(Jiang et al say they tried it with debt in the VAR and claim it doesn’t make much difference.  But their response functions with debt in the VAR, at left,  show even more overshooting than in my example, so I don’t see how they avoid all the predictions of a small (a(beta)), including a low bond premium.)

A lot of literature on fiscal theory and fiscal sustainability, including my own past papers, used AR(1) or similar surplus processes that don’t allow (a(beta)) near zero. I think a lot of the puzzles that literature encountered comes out of this auxiliary specification. Nothing in fiscal theory prohibits a surplus process with (a(beta)=0) and certainly not (0 lt a(beta)lt 1).

Update

Jiang et al. also claim that it is impossible for any government with a unit root in GDP to issue risk free debt. The hidden assumption is easy to root out. Consider the permanent income model, [ c_t = rk_t + r beta sum beta^j y_{t+j}] Consumption is cointegrated with income and the value of debt. Similarly, we would normally write the surplus process [ s_t = alpha b_t + gamma y_t. ] responding to both debt and GDP. If surplus is only cointegrated with GDP, one imposes ( alpha = 0), which amounts to assuming that governments do not repay debts. The surplus should be cointegrated with GDP and with the value of debt.  Governments with unit roots in GDP can indeed promise to repay their debts.



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