Optimal Debt Maturity under EMU

A standard result of optimal debt management models is that in a world of complete markets, where policymakers can make credible announcements, the maturity structure of government debt is totally irrelevant. This paper investigates the role of debt maturity in a very simple context in which policy precommitment is allowed but state-contingent debt cannot be issued and a constraint on the level of deficit is imposed. In line with the optimal taxation approach, in such a context debt maturity has a role to play. In fact, an appropriate choice of the maturity structure may remove the inefficiency introduced by the constraint on excessive deficits, making complete tax smoothing achievable when otherwise it would not be. Optimal maturity is shown to depend on the stochastic structure of the economy. In particular, it lengthens with the volatility of the interest rate and the size of debt; it shortens with the volatility of government spending and in the presence of a negative correlation between changes in interest rates and government financing needs. This suggests that, among the countries joining the European Union, Italy is the one that most needs to lengthen the maturity of its public debt. By looking at the evidence in some EU countries, the paper further investigates whether the introduction of constraints on deficit and debt levels has determined a change in debt management policies. This indirectly provides a test of the optimal taxation argument for public debt design.