Optimal Debt Policy Under Asymmetric Risk

22 Pages Posted: 9 Dec 2016

See all articles by Julio Escolano

Julio Escolano

International Monetary Fund (IMF) - Fiscal Affairs Department

Vitor Gaspar

European Commission

Date Written: August 2016

Abstract

In the paper we show that, most of the time, smooth reduction in the debt ratio is optimal for tax-smoothing purposes when fiscal risks are asymmetric, with large debt-augmenting shocks more likely than commensurate debt reducing shocks. Asymmetric risks are a feature of 200 years of data for the U.S. and the U.K.: rare but recurrent large surges of the debt-to-GDP ratio, followed by very gradual but persistent declines over long periods. More informal evidence from many other countries suggests that asymmetry is a general feature of fiscal shocks. The gradual smooth reduction in the public debt to GDP ratio is not a response to past developments. Instead it is optimal given recurrent fiscal risks and the empirical characteristics of fiscal shocks. The behavior of the debt-to-GDP ratio in the U.K. and the U.S. seems roughly compatible with the prescriptions of the tax-smoothing model.

Keywords: Debt strategy, Fiscal risk, Public debt, Debt service ratios, Debt reduction, Government Debt, Optimal Debt Policies, Fiscal Risks, Fiscal Shocks.

JEL Classification: E60, E61, E62, E65, H21, H62, H63

Suggested Citation

Escolano, Julio and Gaspar, Vitor, Optimal Debt Policy Under Asymmetric Risk (August 2016). IMF Working Paper No. 16/178, Available at SSRN: https://ssrn.com/abstract=2882616

Julio Escolano (Contact Author)

International Monetary Fund (IMF) - Fiscal Affairs Department

700 19th Street, NW
Washington, DC 20431
United States

Vitor Gaspar

European Commission ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7200 (Phone)
+49 69 1344 6575 (Fax)

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