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Optimal Management of Indexed and Nominal Debt

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  • Robert Barro

    ()
    (Department of Economics , Harvard University)

Abstract

A tax-smoothing objective is used to assess the optimal composition of public debt with respect to maturity and contingencies. This objective motivates the government to make its debt payouts contingent on the levels of public outlay and the tax base. If these contingencies are present, but asset prices of non-contingent indexed debt are stochastic, then full tax smoothing dictates an optimal maturity structure of the non-contingent debt. If the certaintyequivalent outlays are the same for each period, then the government should guarantee equal real payouts in each period, that is, the debt takes the form of indexed consols. This structure insulates the government¡¯s budget constraint from unpredictable variations in the market prices of indexed bonds of various maturities. If contingent debt is precluded, then the government may want to depart from a consol maturity structure to exploit covariances among public outlay, the tax base, and the term structure of real interest rates. However, if moral hazard is the reason for the preclusion of contingent debt, then this consideration also deters exploitation of these covariances and tends to return the optimal solution to the consol maturity structure. The issue of nominal bonds may allow the government to exploit the covariances among public outlay, the tax base, and the rate of inflation. But if moral-hazard explains the absence of contingent debt, then the same reasoning tends to make nominal debt issue undesirable. The bottom line is that an optimal-tax approach to public debt favors bonds that are indexed and long term.

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Bibliographic Info

Article provided by Society for AEF in its journal Annals of Economics and Finance.

Volume (Year): 4 (2003)
Issue (Month): 1 (May)
Pages: 1-15

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Handle: RePEc:cuf:journl:y:2003:v:4:i:1:p:1-15

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Keywords: Indexed debt; Nominal debt;

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  1. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 1987. "Time Consistency of Fiscal and Monetary Policy," Econometrica, Econometric Society, vol. 55(6), pages 1419-31, November.
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  3. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  4. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  5. Fischer, Stanley, 1983. "`Optimal fiscal and monetary policy in an economy without capital' by Robert E. Lucas and Nancy L. Stokey," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 95-99.
  6. Robert J. Barro, 1995. "Optimal Debt Management," NBER Working Papers 5327, National Bureau of Economic Research, Inc.
  7. Alesina, Alberto F & Prati, Alessandro & Tabellini, Guido, 1989. "Public Confidence and Debt Management: A Model and a Case Study of Italy," CEPR Discussion Papers 351, C.E.P.R. Discussion Papers.
  8. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
  9. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-30, December.
  10. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  12. Bohn, Henning, 1988. "Why do we have nominal government debt?," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 127-140, January.
  13. Persson, Torsten & Svensson, Lars E. O., 1984. "Time-consistent fiscal policy and government cash-flow," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 365-374, November.
  14. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
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Cited by:
  1. Faraglia, Elisa & Marcet, Albert & Scott, Andrew, 2010. "In search of a theory of debt management," Journal of Monetary Economics, Elsevier, vol. 57(7), pages 821-836, October.
  2. Hans J. Blommestein & Anja Hubig, 2012. "A Critical Analysis of the Technical Assumptions of the Standard Micro Portfolio Approach to Sovereign Debt Management," OECD Working Papers on Sovereign Borrowing and Public Debt Management 4, OECD Publishing.
  3. Hatcher, Michael, 2013. "The Inflation Risk Premium on Government Debt in an Overlapping Generations Model," SIRE Discussion Papers 2013-81, Scottish Institute for Research in Economics (SIRE).
  4. Heng-fu Zou, 2011. "Foreign Asset Accumulation and Macroeconomic Policies in a Model of Mercantilism," CEMA Working Papers 432, China Economics and Management Academy, Central University of Finance and Economics.
  5. Matthias Doepke & Martin Schneider, 2006. "Inflation as a Redistribution Shock: Effects on Aggregates and Welfare," NBER Working Papers 12319, National Bureau of Economic Research, Inc.
  6. Kenneth Kletzer, 2006. "International Financial Integration, Sovereignty, and Constraintson Macroeconomic Policies," IMF Working Papers 06/79, International Monetary Fund.
  7. Bruno Pires Tiberto & Helder Ferreira De Mendonça, 2014. "Social Security And Public Debt: Empirical Evidence For The Brazilian Economy," Anais do XLI Encontro Nacional de Economia [Proceedings of the 41th Brazilian Economics Meeting] 066, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  8. Gerardo M Licandro, 2001. "Monetary Policy Coordination, Monetary Integration and other essays," Levine's Working Paper Archive 625018000000000172, David K. Levine.
  9. Johannes Holler, 2013. "Funding Strategies of Sovereign Debt Management: A Risk Focus," Monetary Policy & the Economy, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 51–74.
  10. Wang, Gaowang & Zou, Heng-fu, 2011. "Mercantilism, Foreign Asset Accumulation and Macroeconomic Policy," MPRA Paper 34519, University Library of Munich, Germany.
  11. Kletzer, Kenneth, 2005. "International Financial Integration, Sovereignty and Constraints on Macroeconomic Policies," Santa Cruz Department of Economics, Working Paper Series qt8n31g89q, Department of Economics, UC Santa Cruz.

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