Advanced Search
MyIDEAS: Login

The social value of risk-free government debt

Contents:

Author Info

  • Stacey Schreft

    ()

  • Bruce Smith

Abstract

This paper considers whether eliminating the stock of government debt outstanding would reduce welfare. It models an economy with three assets—currency, government bonds, and storage, a transactions role for money, and a demand for liquidity and thus a role for banks. The Friedman rule is not optimal in this economy, so there is potentially a role for interest-bearing, risk-free government bonds. Because the government must raise enough revenue to meet its interest obligations on any bonds outstanding, the social value of government debt hinges on whether the benefits from greater portfolio diversification outweigh the costs associated with the necessary revenue-raising efforts. The paper shows that a positive stock of government debt is optimal only if interest payments on the debt are financed via money creation, agents are not too risk averse, there is a primary government budget deficit, and the economy is operating on the bad side of the Laffer curve. But under these conditions, welfare would be even higher if monetary policy were conducted to put the economy on the good side of the Laffer curve and there were no government bonds outstanding. Thus, there is little support for keeping a stock of interest-bearing, risk-free government debt outstanding.

(This abstract was borrowed from another version of this item.)

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://hdl.handle.net/10.1007/s10436-007-0073-3
Download Restriction: Access to full text is restricted to subscribers.

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Springer in its journal Annals of Finance.

Volume (Year): 4 (2008)
Issue (Month): 2 (March)
Pages: 131-155

as in new window
Handle: RePEc:kap:annfin:v:4:y:2008:i:2:p:131-155

Contact details of provider:
Web page: http://www.springerlink.com/link.asp?id=112370

Related research

Keywords: Government debt; Fiscal policy; Monetary policy; Portfolio allocation; E0; E4; E5; E6; H6; G1;

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Stacey L. Schreft & Bruce D. Smith, 2001. "The conduct of monetary policy with a shrinking stock of government debt," Research Working Paper RWP 01-09, Federal Reserve Bank of Kansas City.
  2. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  3. Andrew Abel & Gregory N. Mankiw & Lawrence H. Summers & Richard Zeckhauser, . "Assessing Dynamic Efficiency: Theory and Evidence," Rodney L. White Center for Financial Research Working Papers 14-88, Wharton School Rodney L. White Center for Financial Research.
  4. Smith, B.D. & Villamil, A.P., 1991. "Government Borrowing using Bonds with Randomly Determined Returns : Welfare Improving Randomization in the Context of Deficit Finance," RCER Working Papers 287, University of Rochester - Center for Economic Research (RCER).
  5. de V. Cavalcanti, Tiago V. & Villamil, Anne P., 2003. "Optimal Inflation Tax And Structural Reform," Macroeconomic Dynamics, Cambridge University Press, vol. 7(03), pages 333-362, June.
  6. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
  7. Beatrix Paal & Bruce D. Smith, 2013. "The sub-optimality of the Friedman rule and the optimum quantity of money," Annals of Economics and Finance, Society for AEF, vol. 14(2), pages 911-948, November.
  8. Stacey L. Schreft & Bruce D. Smith, 1997. "The evolution of cash transactions: some implications for monetary policy," Financial Services working paper 97-04, Federal Reserve Bank of Cleveland.
  9. Narayana Kocherlakota, 2003. "Societal Benefits of Illiquid Bonds," Levine's Working Paper Archive 506439000000000300, David K. Levine.
  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. Chari, V.V. & Kehoe, Patrick J., 1999. "Optimal fiscal and monetary policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745 Elsevier.
  12. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  13. Caporale, Tony & Grier, Kevin B, 2000. "Political Regime Change and the Real Interest Rate," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 320-34, August.
  14. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  15. S Rao Aiyagari & Mark Gertler, 1997. "Asset Returns with transaction costs and uninsured individual risk," Levine's Working Paper Archive 648, David K. Levine.
  16. S. Rao Aiyagari & Ellen R. McGrattan, 1994. "The optimal quantity of debt," Working Papers 538, Federal Reserve Bank of Minneapolis.
  17. Bruce Smith & J. Bhattacharya & Mark Guzman, 1998. "Some Even More Unpleasant Monetarist Arithmetic," Canadian Journal of Economics, Canadian Economics Association, vol. 31(3), pages 596-623, August.
  18. George J. Hall & Stefan Krieger, 2000. "Tax Smoothing Implications of the Federal Debt Paydown," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 253-302.
  19. Robert J. Barro, 1997. "Optimal Management of Indexed and Nominal Debt," NBER Working Papers 6197, National Bureau of Economic Research, Inc.
  20. Bruce D. Smith, 2003. "Taking intermediation seriously," Proceedings, Federal Reserve Bank of Cleveland, pages 1319-1377.
  21. Romer, David, 1993. "Why Should Governments Issue Bonds?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 163-75, May.
  22. S. Rao Aiyagari & Mark Gertler, 1990. "Asset Returns with Transactions Cost and Uninsured Risk: A Stage III Exercise," NBER Working Papers 3481, National Bureau of Economic Research, Inc.
  23. Villamil, Anne P., 1988. "Price discriminating monetary policy : A nonuniform pricing approach," Journal of Public Economics, Elsevier, vol. 35(3), pages 385-392, April.
  24. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Joe Haslag & Antoine Martin, 2003. "Optimality of the Friedman Rule in Overlapping Generations Model with Spatial Separation," Working Papers 0306, Department of Economics, University of Missouri.
  2. Joseph H. Haslag & Antoine Martin, 2007. "Optimality of the Friedman Rule in an Overlapping Generations Model with Spatial Separation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1741-1758, October.
  3. Bhattacharya, Joydeep & Singh, Rajesh, 2008. "Optimal choice of monetary policy instruments in an economy with real and liquidity shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 32(4), pages 1273-1311, April.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:kap:annfin:v:4:y:2008:i:2:p:131-155. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Guenther Eichhorn) or (Christopher F. Baum).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.