Working Paper: NBER ID: w20632
Authors: Davide Debortoli; Ricardo Nunes; Pierre Yared
Abstract: This paper develops a model of optimal government debt maturity in which the government cannot issue state-contingent bonds and cannot commit to fiscal policy. If the government can perfectly commit, it fully insulates the economy against government spending shocks by purchasing short-term assets and issuing long-term debt. These positions are quantitatively very large relative to GDP and do not need to be actively managed by the government. Our main result is that these conclusions are not robust to the introduction of lack of commitment. Under lack of commitment, large and tilted positions are very expensive to finance ex-ante since they exacerbate the problem of lack of commitment ex-post. In contrast, a flat maturity structure minimizes the cost of lack of commitment, though it also limits insurance and increases the volatility of fiscal policy distortions. We show that the optimal time-consistent maturity structure is nearly flat because reducing average borrowing costs is quantitatively more important for welfare than reducing fiscal policy volatility. Thus, under lack of commitment, the government actively manages its debt positions and can approximate optimal policy by confining its debt instruments to consols.
Keywords: government debt; debt maturity; fiscal policy
JEL Codes: E62; H21; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government debt maturity (H63) | government's ability to manage fiscal policy effectively (E62) |
| tilted maturity structure (G32) | decrease in market value of government liabilities (H63) |
| lack of commitment (J22) | optimal maturity structure shifts to flat configuration (G32) |
| flat maturity structure (E43) | minimizes costs of managing large and tilted debt positions (G32) |
| lack of commitment (J22) | recommendation for government to maintain flat maturity structure (E60) |
| flat maturity structure (E43) | aligns government's ex-ante preferences with ex-post outcomes (D78) |