Optimal Time-Consistent Government Debt Maturity

46 Pages Posted: 21 Oct 2014 Last revised: 1 Jan 2016

See all articles by Davide Debortoli

Davide Debortoli

Universitat Pompeu Fabra - Department of Economics and Business; Barcelona Graduate School of Economics (Barcelona GSE)

Ricardo Cavaco Nunes

Federal Reserve Banks - Federal Reserve Bank of Boston

Pierre Yared

Columbia Business School - Finance and Economics

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Date Written: December 31, 2015

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: Public debt, optimal taxation, fiscal policy

JEL Classification: H63, H21, E62

Suggested Citation

Debortoli, Davide and Nunes, Ricardo Cavaco and Yared, Pierre, Optimal Time-Consistent Government Debt Maturity (December 31, 2015). Columbia Business School Research Paper No. 14-56, Available at SSRN: https://ssrn.com/abstract=2512587 or http://dx.doi.org/10.2139/ssrn.2512587

Davide Debortoli

Universitat Pompeu Fabra - Department of Economics and Business ( email )

Barcelona
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Ricardo Cavaco Nunes

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

Pierre Yared (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
Uris Hall
New York, NY 10027
United States

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