Managing Debt Stability

25 Pages Posted: 28 Jan 2005

See all articles by Alessandro Missale

Alessandro Missale

University of Milan - Department of Business Policy and Economics

Emanuele Bacchiocchi

Università degli Studi di Milano

Date Written: January 2005

Abstract

This paper presents a simple model in which debt management stabilizes the debt-to-GDP ratio in face of shocks to real returns and output growth and thus supports fiscal restraint in ensuring sustainability. The optimal composition of public debt is derived by looking at the relative impact of the risk and cost of alternative debt instruments on the cost of missing the stabilization target. The optimal debt structure is a function of the expected return differentials between debt instruments, of the conditional variance of their returns and of the conditional covariances of their returns with output growth and inflation. We then explore how the relevant covariances and thus the optimal choice of debt instruments depend on the monetary regime and on Central Bank preferences for output stabilization, inflation control and interest rate smoothing. Finally, we estimate the composition of public debt that would have supported debt stabilization in OECD countries over the last two decades. The empirical evidence suggests that the public debt should have a long maturity and a large share of it should be indexed to the price level.

Keywords: debt management, debt structure, debt stabilization, inflation indexation, interest rates

JEL Classification: E63, H63

Suggested Citation

Missale, Alessandro and Bacchiocchi, Emanuele, Managing Debt Stability (January 2005). Available at SSRN: https://ssrn.com/abstract=655741 or http://dx.doi.org/10.2139/ssrn.655741

Alessandro Missale (Contact Author)

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

Via Conservatorio 7
I-20122 Milano
Italy

Emanuele Bacchiocchi

Università degli Studi di Milano ( email )

Milan, 20122
Italy

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