Optimal Debt Management with a Stability and Growth Pact

28 Pages Posted: 6 Dec 2004

See all articles by Alessandro Missale

Alessandro Missale

University of Milan - Department of Business Policy and Economics

Date Written: March 2000

Abstract

The Stability and Growth Pact introduces deficit stabilization as a new interesting objective of debt management. The interest payments on public debt may serve as an important buffer against the budget consequences of cyclical downturns and unexpected deflation. The optimal debt composition depends on the correlations between interest rates, output and inflation. Estimated correlations for the period 1960-1988 and the implied debt compositions provide benchmarks for implications regarding the EMU. The paper explores how relevant correlations between output, inflation and interest rates may have changed with the shift in the monetary policy regime and thus how the debt composition, which stabilizes the dificit, has changed. A longer maturity structure of conventional debt is optimal if the ECB places a lower weight on output stabilization then the national monetary authorities and if EMU member states are hit by asymmetric shocks. Short term conventional debt should instead be issued by countries which experience a relatively higher output and inflation uncertainty and a lower sensitivity of aggregate demand to interest-rate changes. The optimal share of inflation indexed debt is largest in a strict inflation targeting regime; the lower the weight that the ECB assigns to output stabilization, the more attractive is inflation indexation for deficit stabilization.

Suggested Citation

Missale, Alessandro, Optimal Debt Management with a Stability and Growth Pact (March 2000). Available at SSRN: https://ssrn.com/abstract=627343 or http://dx.doi.org/10.2139/ssrn.627343

Alessandro Missale (Contact Author)

University of Milan - Department of Business Policy and Economics ( email )

Via Conservatorio 7
I-20122 Milano
Italy

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