BEIJING, Nov. 14, 2024 /PRNewswire/ -- Professor Neng Wang, Dean's Distinguished Chair Professor of Finance and Senior Associate Dean at Cheung Kong Graduate School of Business (CKGSB), recently co-authored a paper with Nobel laureate Thomas J. Sargent, among others, published in PNAS entitled "Managing Government Debt". PNAS, or the Proceedings of the National Academy of Sciences, is the journal of the US National Academy of Sciences, often known as one of the three most prestigious general-science journals alongside Nature and Science.

The paper works out a new stochastic model of tax rates and debt/GDP framework for governments to improve fiscal management in uncertain times.

A low debt-to-GDP ratio signals a country is producing more than it owes, placing it on a strong financial footing, whereas a high ratio imperils public services and asset transfer between rich and poor, as a government is pushed to tax more and spend less. The authors extended Barro's model with the risks and opportunities parameters and argue that a government should keep its debt-GDP ratio stable and adopt a stable tax rate that can finance a certain amount of its surplus to GDP. They found that by buying or selling Shiller GDP-linked securities, a government can hedge its primary surplus risk, get risk-free debt, stabilize its debt-to-GDP ratio and keep tax rates level, hence becoming more financially sustainable.

The study offers guidance for finance ministers and the economists behind them to manage government debt with a sustainable mindset, as governments struggle with public spending caps in a post-COVID crisis era.

This paper is co-authored by Neng Wang, CKGSB Dean's Distinguished Chair Professor of Finance; Thomas J. Sargent, Nobel Prize winner in Economics, Professor of Economics at New York University and Senior Fellow at the Hoover Institution at Stanford University; Professor Wei Jiang of the Department of Industrial Engineering and Decision Analytics at the Hong Kong University of Science and Technology; and Professor Jinqiang Yang of the School of Finance at Shanghai University of Finance and Economics. 

A follow-up study, already accepted by the Journal of Finance, entitled "A p Theory of Taxes and Debt Management", sees Professor Neng Wang and his co-authors, further exploring the factors that determine the maximal sustainable government debt-to-GDP ratio by showing what happens if there is a debt default.