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Optimal Public Debt Management and Liquidity Provision

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  • George-Marios Angeletos
  • Fabrice Collard
  • Harris Dellas
  • Behzad Diba

Abstract

We study the Ramsey policy problem in an economy in which firms face a collateral constraint. Issuing more public debt alleviates this friction by increasing the aggregate quantity of collateral. In so doing, however, the issuance of more debt also raises interest rates, which in turn increases the tax burden of servicing the entire outstanding debt. We first document how this trade-off upsets the optimality of tax smoothing and, in contrast to the standard paradigm, helps induce a unique and stable steady-state level of debt in the deterministic version of the model. We next study the optimal policy response to fiscal and financial shocks in the stochastic version. We finally show how the results extend to a variant model in which the financial friction afflicts consumers rather than firms.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18800.

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Date of creation: Feb 2013
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Handle: RePEc:nbr:nberwo:18800

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  1. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers, Federal Reserve Bank of Minneapolis 502, Federal Reserve Bank of Minneapolis.
  2. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
  3. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  4. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 55-93.
  6. Emmanuel Farhi, 2007. "Capital Taxation and Ownership when Markets are Incomplete," NBER Working Papers 13390, National Bureau of Economic Research, Inc.
  7. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, American Economic Association, vol. 80(2), pages 382-88, May.
  8. Francisco J. Buera & Benjamin Moll, 2012. "Aggregate Implications of a Credit Crunch," NBER Working Papers 17775, National Bureau of Economic Research, Inc.
  9. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2012. "The Aggregate Demand for Treasury Debt," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 120(2), pages 233 - 267.
  10. Edouard Challe & Xavier Ragot, 2011. "Fiscal Policy in a Tractable Liquidity‐Constrained Economy," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 121(551), pages 273-317, March.
  11. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report, Federal Reserve Bank of Minneapolis 346, Federal Reserve Bank of Minneapolis.
  12. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 109(4), pages 841-79, November.
  13. George-Marios Angeletos, 2002. "Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 117(3), pages 1105-1131, August.
  14. S. Rao Aiyagari & Ellen R. McGrattan, 1994. "The optimal quantity of debt," Working Papers, Federal Reserve Bank of Minneapolis 538, Federal Reserve Bank of Minneapolis.
  15. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, Oxford University Press, vol. 127(3), pages 1469-1513.
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