Working Paper: CEPR ID: DP16304
Authors: Zhengyang Jiang; Hanno Lustig; Stijn Van Nieuwerburgh; Mindy Xiaolan
Abstract: Governments face a trade-off between insuring bondholders and insuring taxpayers against output shocks. If they insure bondholders by manufacturing risk-free zero-beta debt, then they can only provide limited insurance to taxpayers. Taxpayers will pay more taxes in bad times regardless of whether output shocks are permanent or temporary. Permanent shocks impute long-run output risk to the debt while transitory shocks impute interest rate risk, all of which must be offset through taxation to keep the debt safe. Conversely, if governments insure taxpayers against adverse macro shocks, then the debt becomes risky. Convenience yields on government debt temporarily alleviate the trade-off.
Keywords: Fiscal Policy; Term Structure; Debt Maturity; Convenience Yield
JEL Codes: G12; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government's decision to insure bondholders (G28) | Limited taxpayer insurance (G52) |
| Permanent output shocks (E39) | Higher taxation to maintain debt safety (H69) |
| Temporary output shocks (E39) | Interest rate risk (E43) |
| Higher debt levels (H63) | Exacerbation of tradeoff between insuring bondholders and taxpayers (G28) |
| Convenience yields on government debt (E43) | Alleviation of tradeoff (F16) |
| Riskiness of debt increases when prioritizing taxpayer insurance over bondholder insurance (G33) | Shifting burden of risk away from bondholders (G32) |