Working Paper: NBER ID: w24534
Authors: Marina Azzimonti; Pierre Yared
Abstract: We develop a theory of optimal government debt in which publicly-issued and privately-issued safe assets are substitutes. While government bonds are backed by future tax revenues, privately-issued safe assets are backed by the future repayment of pools of defaultable private loans. We find that a higher supply of public debt crowds out privately-issued safe assets less than one for one and reduces the interest spread between borrowing and deposit rates. Our main result is that the optimal level of public debt does not fully crowd out private lending and maintains a positive interest spread. Moreover, the optimal level of public debt is higher the more severe are financial frictions.
Keywords: Public Debt; Private Assets; Financial Frictions
JEL Codes: E21; E25; E62; H21; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in public debt (H69) | Reduction in interest spread (E43) |
| Reduction in interest spread (E43) | Slackening of financial constraints on borrowing households (G51) |
| Slackening of financial constraints on borrowing households (G51) | Lower probability of default (G33) |
| Severity of financial frictions (G19) | Optimal level of public debt (H63) |
| Government borrowing at lower interest rate than households (G51) | Affects borrowing decisions (G21) |
| Public debt (H63) | Partial crowd-out of private lending (H81) |
| Increase in public debt (H69) | Greater financial market efficiency (G19) |
| Increase in public debt (H69) | Increase in inequality (D31) |