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Optimal Debt Management with a Stability and Growth Pact

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  • Alessandro Missale

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 1960-1998 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 deficit, has changed. A longer maturity structure of conventional debt is optimal if the ECB places a lower weight on output stabilization than 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.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 166.

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Handle: RePEc:igi:igierp:166

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Cited by:
  1. Michael J. Artis & Marco Buti, 2000. "Close to Balance or in Surplus. A Policy Maker’s Guide to the Implementation of the Stability and Growth Pact," EUI-RSCAS Working Papers, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS) 28, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
  2. Michele Manna & Emmanuela Bernardini & Mauro Bufano & Davide Dottori, 2013. "Modelling public debt strategies," Questioni di Economia e Finanza (Occasional Papers), Bank of Italy, Economic Research and International Relations Area 199, Bank of Italy, Economic Research and International Relations Area.
  3. Udaibir S. Das & Yinqiu Lu & Michael G Papaioannou & Iva Petrova, 2012. "Sovereign Risk and Asset and Liability Management," IMF Working Papers, International Monetary Fund 12/241, International Monetary Fund.
  4. Sieg, Gernot & Stegemann, Ulrike, 2009. "Strategic debt management within the stability and growth pact," Economics Department Working Paper Series, Technische Universität Braunschweig, Economics Department 5, Technische Universität Braunschweig, Economics Department.
  5. Francesco Giavazzi & Alessandro Missale, 2004. "Public Debt Management in Brazil," NBER Working Papers 10394, National Bureau of Economic Research, Inc.
  6. Zorica Raspudic Golomejic, 2007. "Coordination of Public Debt Management and Running Monetary Policy in Croatia," Financial Theory and Practice, Institute of Public Finance, Institute of Public Finance, vol. 31(2), pages 153-183.
  7. Giorgio Basevi & Lorenzo Pecchi & Gustavo Piga, 2005. "Parallel Monies, Parallel Debt: Lessons from the EMU and Options for the New EU," CEIS Research Paper, Tor Vergata University, CEIS 68, Tor Vergata University, CEIS.

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