A Goldilocks Theory of Fiscal Deficits

This paper develops a tractable continuous-time model to study the fiscal sustainability of government deficits and the joint dynamics of public debt, with two main ingredients: an endogenous interest rate R that rises with the debt level through a convenience yield mechanism (savers value holding government bonds), and a potentially binding zero lower bound (ZLB) on the nominal interest rate. The paper’s central theoretical contribution is deriving the correct free-lunch condition: not the commonly cited $R < G$, but the stricter condition $R < G - \varphi$, where $\varphi$ captures the sensitivity of $R - G$ to debt. Even when $R < G$, accumulating more debt raises R through reduced convenience yields, and this endogenous feedback tightens fiscal sustainability. The paper maps the full deficit-debt space with a hump-shaped locus, analyzes ZLB dynamics where the deficit-debt relationship can invert, and studies the role of income inequality and tax policy. Calibrating to U.S. and Japan as of December 2019, the paper finds little room for free-lunch policies in the U.S. — a maximum permanent deficit of just over 2% of GDP at a stable debt-to-GDP ratio of 110% — while Japan is in the “inverted” ZLB regime where deficit increases can reduce debt through higher nominal growth.

Dynamics of the Long-Term Housing Yield: Evidence from Natural Experiments

Each month a fraction of UK property leases are extended by 90 years or more, creating thousands of natural experiments in which the same property’s rent and capital value are revealed simultaneously. This paper uses these lease extensions — and Massachusetts and Cambridge rent-control removals as a second identification strategy — to estimate the expected long-term housing yield (annual rent-to-price ratio) and decompose its dynamics into rent-growth expectations and discount-rate components. The central finding is that housing yield movements are dominated by discount-rate shocks: variation in required returns on housing explains the overwhelming majority of yield variance, while expected rent growth contributes less than 10 percent. Housing booms are therefore primarily driven by falling required returns, not by rational expectations of higher future rents. The yield responds to real long-term interest rates with a slope significantly below one, consistent with a non-pecuniary convenience yield on housing that is not fully displaced by interest rate changes.

Atif Mian | Macro Paper Warehouse

A Goldilocks Theory of Fiscal Deficits

Dynamics of the Long-Term Housing Yield: Evidence from Natural Experiments