Single-equation estimates of fiscal reaction functions, which relate primary surpluses to past debt-GDP ratios and control variables, are subject to potentially serious simultaneity bias that can produce misleading inferences about fiscal behavior. Biases arise from failure to model the general equilibrium relationships between government debt and surpluses, relationships that bring in the forward-looking nature of nominal debt valuation and the role of monetary policy in that valuation.
We thank Nora Traum and Todd Walker for comments. This project is supported by National Natural Science Foundation of China (No. 71103103) and Tsinghua University Initiative Scientific Research Program (No. 20151080392). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Leeper, Eric M. & Li, Bing, 2017. "Surplus–debt regressions," Economics Letters, Elsevier, vol. 151(C), pages 10-15. citation courtesy of