Government Debt Valuation and Sustainability

We study what investors and voters believe supports the value of U.S. government debt. In survey evidence from bond investors and registered voters, we ask respondents to allocate debt value across future primary surpluses, safe-asset demand, rollover, central-bank support, government assets, and financial repression. Many respondents put less weight on future surpluses than standard fiscal theories imply, while assigning substantial weight to safe-asset demand and central-bank support. The findings help explain why U.S. debt can appear stable despite weak fiscal fundamentals, but also why that stability may be fragile if beliefs supporting Treasury safe-asset status shift.

We show that quantitative easing (QE) worsens government debt sustainability. In our model, the government runs a primary deficit with elastic debt demand that makes interest rates endogenous. The central bank has long-term capital and remits profits to the fiscal authority. QE depletes this capital stock, reducing future remittances and crisis-fighting reserves. Contrary to Sargent and Wallace (1981), where greater monetary accommodation lowers the steady-state debt level, we show that QE increases the steady-state level of debt and shifts the default boundary inward, thus heightening fragility and reducing debt sustainability. Moreover, while QE can keep interest rates low for extended periods, continued debt accumulation eventually triggers a sharp rise in financing costs. Under certain parameters, large-scale QE makes previously sustainable debt levels unsustainable, leading ultimately to sovereign default.

We study whether the U.S. Treasury market enforces fiscal discipline and which investors drive that mechanism. Using granular sector-level Treasury holdings by investor type and maturity, we connect investor demand to news about future primary surpluses. Long-term investors, especially pension funds and life insurers, are more responsive to fiscal surplus news in long-term Treasuries, while broker-dealers and hedge funds are much less responsive. Fiscal discipline depends on who owns the debt, and aggregate market reactions can be muted when large holders value Treasuries for liquidity, regulation, reserves, or policy reasons.

We study how financial markets shape fiscal policy through the cost of servicing government debt. The paper shifts focus from debt-to-GDP ratios to interest service costs, the immediate cash-flow pressure created by debt. Using long historical data for the United States and United Kingdom and a panel of developed countries, we estimate whether governments raise primary surpluses when interest costs rise. The results link asset pricing and public finance by showing how risk premia, interest rates, and investor demand affect the budget pressure governments face.