Working Paper: NBER ID: w27786
Authors: Zhengyang Jiang; Hanno Lustig; Stijn van Nieuwerburgh; Mindy Z. Xiaolan
Abstract: Governments face a trade-off between insuring bondholders and insuring taxpayers against output risk. If they insure bondholders by manufacturing risk-free zero-beta debt, then their capacity to insure taxpayers by lowering tax rates or raising government spending during recessions is limited. Using asset pricing tools, we develop a sufficient statistic for taxpayer insurance possibilities over different horizons, and characterize it analytically as a function of the debt/output, spending/output, and pricing kernel dynamics. With permanent shocks, taxpayers can only be insured over short horizons through counter-cyclical debt issuance. The horizon shrinks as the debt/output ratio reverts faster to its mean. The trade-off worsens if the output shocks are transitory instead of permanent. As the world’s safe asset supplier, the U.S. relies on strongly counter-cyclical debt issuance to provide more short-run insurance to its taxpayers.
Keywords: Government Debt; Taxpayer Insurance; Bondholders; Output Risk; Fiscal Policy
JEL Codes: F34; G12; H62; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Risk-free debt (H63) | Tradeoff between insuring bondholders and taxpayers (G32) |
| Debt-output ratio increases (H69) | Diminished insurance provided to taxpayers (G52) |
| Output shocks (E39) | Tradeoff between insuring bondholders and taxpayers (G32) |
| Strong countercyclical debt issuance (H63) | Temporary insurance to taxpayers (G52) |
| Riskiness of surpluses (D81) | Constraints on taxpayer insurance (G52) |