Testing intertemporal budget constraints: theory and applications to U. S. federal budget and current account deficits

Previous tests of intertemporal budget balance and present value relationships have generally assumed either a constant discount rate or a constant expected discount rate. Empirical applications of these tests to the study of U.S. government deficits have produced conflicting results. This paper extends this recent work by deriving a testable condition that is sufficient to ensure intertemporal budget balance as long as the expected discount rate is strictly positive. ; We use our test to ask whether the U.S. budget and current account deficits are sustainable. Using postwar annual data, we show that the federal budget process is consistent with intertemporal budget balance, but that the process for the current account may not be.