Explosive U.S. budget deficit

In this study, we present new evidence that the postwar U.S. federal budget deficit was explosive in nature. Because of the government's inevitable attempts to reduce high or rapidly growing budget deficits, the deficit may contain a substantial component that periodically collapses, which renders the standard unit root tests biased toward stationarity. We apply a newly proposed recursive unit root test for explosiveness, which is known to be powerful to the periodically collapsing component. Although the evidence for explosiveness we found herein is not overwhelming, this study should at the very least serve as a warning against a blind application of standard unit root tests to budget deficits, which may harbor components that periodically collapse.

► We argue that budget deficits should contain components that collapse periodically. ► Standard unit root tests are biased for periodically collapsing components. ► Standard unit root tests find the postwar U.S. budget deficit stationary. ► With a new test, some evidence is found for explosiveness in the US budget deficit.