SUSTAINABILITY OF THE DEFICIT PROCESS WITH STRUCTURAL SHIFTS

This article discusses the condition for deficit sustainability and searches for shifts in the structure of the U.S. deficit policy. I show that, contrary to the current literature, cointegration between revenues and expenditures inclusive of debt payment is not a necessary but a sufficient condition for a strict interpretation of deficit sustainability. The necessary condition requires that debt grow slower than the borrowing rate. For tests an structural shifts, I use a test for structural change that searches for shifts in the rank of the cointegrating matrix. I find that there is a shift in deficit policy in the early 80s so that cointegration between revenue and expenditure inclusive of interest payments holds only up to 1980. I show, however, that the deficit process is still sustainable despite the failure of cointegration in the 80s. The finding of shifts in the deficit process is more uncertain when I normalize by gross national product or population, but the deficit is shown to be sustainable regardless of whether or not structural breaks exist in the data.