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Manufacturing Risk-free Government Debt

Author

Listed:
  • Van Nieuwerburgh, Stijn
  • Jiang, Zhengyang
  • Lustig, Hanno
  • Xiaolan, Mindy

Abstract

Governments face a trade-off between insuring bondholders and insuring taxpayers against output shocks. If they insure bondholders by manufacturing risk-free zero-beta debt, then they can only provide limited insurance to taxpayers. Taxpayers will pay more taxes in bad times regardless of whether output shocks are permanent or temporary. Permanent shocks impute long-run output risk to the debt while transitory shocks impute interest rate risk, all of which must be offset through taxation to keep the debt safe. Conversely, if governments insure taxpayers against adverse macro shocks, then the debt becomes risky. Convenience yields on government debt temporarily alleviate the trade-off.

Suggested Citation

  • Van Nieuwerburgh, Stijn & Jiang, Zhengyang & Lustig, Hanno & Xiaolan, Mindy, 2021. "Manufacturing Risk-free Government Debt," CEPR Discussion Papers 16304, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16304
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    2. Corhay, Alexandre & Kind, Thilo & Kung, Howard & Morales, Gonzalo, 2021. "Discount rates, debt maturity, and the fiscal theory," SAFE Working Paper Series 323, Leibniz Institute for Financial Research SAFE.
    3. Jiang, Zhengyang, 2021. "US Fiscal cycle and the dollar," Journal of Monetary Economics, Elsevier, vol. 124(C), pages 91-106.
    4. Gaetano Bloise & Pietro Reichlin, 2023. "Low safe interest rates: A case for dynamic inefficiency?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 633-656, December.
    5. Debrun, Xavier & Masuch, Klaus & Ferrero, Guiseppe & Vansteenkiste, Isabel & Ferdinandusse, Marien & von Thadden, Leopold & Hauptmeier, Sebastian & Alloza, Mario & Derouen, Chloé & Bańkowski, Krzyszto, 2021. "Monetary-fiscal policy interactions in the euro area," Occasional Paper Series 273, European Central Bank.
    6. YiLi Chien & Wenxin Du & Hanno Lustig, 2025. "Japan’s Debt Puzzle: Sovereign Wealth Fund from Borrowed Money," Working Papers 2025-023, Federal Reserve Bank of St. Louis.
    7. Chien, YiLi & Wen, Yi, 2022. "The determination of public debt under both aggregate and idiosyncratic uncertainty," Journal of Economic Theory, Elsevier, vol. 203(C).
    8. Van Nieuwerburgh, Stijn & Elenev, Vadim & Landvoigt, Tim & Shultz, Patrick, 2021. "Can Monetary Policy Create Fiscal Capacity?," CEPR Discussion Papers 16414, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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