Optimal Time-Consistent Government Debt Maturity

47 Pages Posted: 3 Nov 2014

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

Multiple version iconThere are 2 versions of this paper

Date Written: October 2014

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.

Suggested Citation

Debortoli, Davide and Nunes, Ricardo Cavaco and Yared, Pierre, Optimal Time-Consistent Government Debt Maturity (October 2014). NBER Working Paper No. w20632. Available at SSRN: https://ssrn.com/abstract=2518722

Davide Debortoli (Contact Author)

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

Columbia Business School - Finance and Economics ( email )

3022 Broadway
Uris Hall
New York, NY 10027
United States

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