Optimal Time-Consistent Government Debt Maturity
The current literature on a government's optimal debt maturity structure contends that by purchasing short-term assets and selling long-term debt, it is possible to fully insulate the economy against fiscal shocks. The required short and long positions are large relative to GDP and constant. The market value of debt adjusts automatically and the constant debt positions and fluctuating bond prices insulate against potential shocks. However, achieving the goal of averting future shocks depends on the government perfectly committing to the future fiscal policy, for without this sustained commitment, the large debt positions required to insure against future spending shocks are extremely expensive to service; moreover, the government faces a tradeoff between using the debt maturity structure to service its debt obligations and using it to protect against economic shocks. As the authors point out, in practice a government chooses tax, spending, and debt levels sequentially in each period, taking into account its outstanding debt portfolio and anticipating the behavior of future governments. The paper develops an alternative model of optimal debt maturity that solves the problem of a government's lack of commitment.
Key Findings
- When a government lacks commitment, reducing its average borrowing costs has a quantitatively greater impact on welfare than insuring against future shocks.
- Under lack of commitment, the optimal time-consistent maturity structure is nearly flat, so the government owes the same amount at all future dates.
- This smooth maturity structure is achieved by maintaining positive short-term and long-term debt positions and by actively managing these positions. The government holds a negligible and approximately constant short-term bond position, while the majority of its debt is held in a consol. This is a perpetual bond that has a nondecaying fixed payment at all future dates.
- The flat maturity structure remains optimal given different types of fiscal shocks, as well as to productivity and discount factor shocks.
Implications
The evidence is consistent with a positive relationship between trade liberalization and productivity.