Working Paper: CEPR ID: DP15488
Authors: Fabrice Collard; Harris Dellas; Georgemarios Angeletos
Abstract: We study optimal policy in an economy in which public debtis used as collateral or liquidity buffer. Issuing more public debtraises welfare by easing the underlying financial friction; but thiseasing lowers the liquidity premium and increases the government'scost of borrowing. These considerations, which are absent in the basicRamsey paradigm, help pin down a unique, long-run level of publicdebt. They require a front-loaded tax response to government-spendingshocks, instead of tax smoothing. And they explain why a financialrecession, more than a traditional one, makes government borrowingcheaper, optimally supporting larger fiscal stimuli.
Keywords: public debt; private liquidity; optimal policy
JEL Codes: E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| public debt issuance (H63) | welfare (I38) |
| welfare (I38) | liquidity premium (E41) |
| liquidity premium (E41) | government's cost of borrowing (H74) |
| government spending shocks (E62) | front-loaded tax response (H22) |
| front-loaded tax response (H22) | lower interest rates on public debt (H63) |
| lower interest rates on public debt (H63) | larger fiscal stimulus (E62) |
| financial recessions (G01) | lower costs for government borrowing (H74) |
| liquidity provision, interest rate suppression, tax smoothing (E52) | optimal response to fiscal shocks (E63) |