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Public Debt as Private Liquidity: Optimal Policy

Author

Listed:
  • George-Marios Angeletos

    (MIT Department of Economics - MIT - Massachusetts Institute of Technology)

  • Fabrice Collard

    (TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - Comue de Toulouse - Communauté d'universités et établissements de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

  • Harris Dellas

    (UNIBE - Universität Bern = University of Bern = Université de Berne)

Abstract

We study optimal policy in an economy in which public debt is used as collateral or liquidity buffer. Issuing more public debt raises welfare by easing the underlying financial friction; but this easing lowers the liquidity premium and increases the government's cost of borrowing. These considerations, which are absent in the basic Ramsey paradigm, help pin down a unique, long-run level of public debt. They require a front-loaded tax response to government-spending shocks, instead of tax smoothing. And they explain why a financial recession, more than a traditional one, makes government borrowing cheaper, optimally supporting larger fiscal stimuli. * This paper supersedes an earlier draft, entitled "Optimal Public Debt Management and Liquidity Provision", which was concerned with the same topic but did not contain the present paper's theoretical contribution. We are grateful to Behzad Diba for his collaboration on the earlier project; to Pedro Teles and Per Krusell for illuminating discussions; and to various seminar participants for their feedback. Angeletos also thanks the University of Bern, Study Center Gerzensee, and the Swiss Finance Institute for their hospitality.

Suggested Citation

  • George-Marios Angeletos & Fabrice Collard & Harris Dellas, 2023. "Public Debt as Private Liquidity: Optimal Policy ," Working Papers hal-03917771, HAL.
    • Handle: RePEc:hal:wpaper:hal-03917771
    Note: View the original document on HAL open archive server: https://hal.science/hal-03917771v1
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    References listed on IDEAS

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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