Exorbitant Privilege Gained and Lost: Fiscal Implications

This paper studies three centuries of U.K. fiscal history to understand the fiscal implications of safe asset supplier status — what the authors call “exorbitant privilege” — and how it can be gained and lost. Using the discounted cash flow approach to fiscal capacity developed in Jiang, Lustig, Van Nieuwerburgh, and Xiaolan (2019), the paper measures the present discounted value of expected future primary surpluses (inclusive of convenience yield seigniorage) and compares it to the observed market value of outstanding government debt. The central finding is a sharp historical discontinuity: before World War I, when the U.K. was the world’s dominant safe asset supplier and its gilts served as the global reserve asset, roughly only three-quarters of U.K. debt was backed by future surpluses even after accounting for convenience yields earned from global safe asset demand. After World War II, when the U.K. lost its safe asset supplier status to the U.S., the U.K.’s debt became fully backed by surpluses and fiscal capacity became closely tied to its own macro fundamentals. By contrast, the U.S. after World War II shows a pattern similar to the pre-war U.K. but more extreme: less than one-third of outstanding U.S. Treasury debt is backed by future surpluses according to the paper’s estimates, with the gap between debt and estimated fiscal capacity growing sharply over recent decades.

Mindy Z. Xiaolan | Macro Paper Warehouse

Exorbitant Privilege Gained and Lost: Fiscal Implications