Working Paper: NBER ID: w13119
Authors: Laura Alfaro; Fabio Kanczuk
Abstract: We model and calibrate the arguments in favor and against short-term and long-term debt. These arguments broadly include: maturity premium, sustainability, and service smoothing. We use a dynamic equilibrium model with tax distortions and government outlays uncertainty, and model maturity as the fraction of debt that needs to be rolled over every period. In the model, the benefits of defaulting are tempered by higher future interest rates. We then calibrate our artificial economy and solve for the optimal debt maturity for Brazil as an example of a developing country and the U.S. as an example of a mature economy. We obtain that the calibrated costs from defaulting on long-term debt more than offset costs associated with short-term debt. Therefore, short-term debt implies higher welfare levels.
Keywords: debt maturity; sovereign debt; emerging markets; welfare; interest rates
JEL Codes: E62; F34; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| debt maturity (H63) | welfare levels (I30) |
| short-term debt (H63) | welfare levels (I30) |
| long-term debt costs (G32) | short-term debt costs (G32) |
| increased maturity (Y50) | gains from defaulting (G32) |
| optimal debt maturity for Brazil (F34) | exclusively short-term debt (H63) |
| U.S. long maturity (N22) | negligible gains from shortening debt maturity (G32) |
| lengthening debt maturity policies (H63) | lower welfare levels (I30) |