Working Paper: NBER ID: w22794
Authors: Georgemarios Angeletos; Fabrice Collard; Harris Dellas
Abstract: We study optimal policy in an economy in which public debt is used as collateral or liquidity buffer. Issuing more public debt raises welfare by easing the underlying financial friction; but this easing lowers the liquidity premium and increases the government’s cost of borrowing. These considerations, which are absent in the basic Ramsey paradigm, help pin down a unique, long-run level of public debt. They require a front-loaded tax response to government-spending shocks, instead of tax smoothing. And they explain why a financial recession, more than a traditional one, makes government borrowing cheaper, optimally supporting larger fiscal stimuli.
Keywords: Public Debt; Liquidity; Optimal Policy
JEL Codes: D52; D53; E13; E32; E51; E60; H21; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| public debt (H63) | welfare (I38) |
| public debt (H63) | liquidity premium (E41) |
| public debt (H63) | government borrowing costs (H74) |
| liquidity provision (E41) | interest rate suppression (E43) |
| public debt (H63) | financial frictions (G19) |
| financial recessions (G01) | government borrowing costs (H74) |
| government borrowing costs (H74) | fiscal stimuli (E62) |