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Optimal Debt Policy Under Asymmetric Risk

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  • Julio Escolano
  • Vitor Gaspar

Abstract

In the paper we show that, most of the time, smooth reduction in the debt ratio is optimal for tax-smoothing purposes when fiscal risks are asymmetric, with large debt-augmenting shocks more likely than commensurate debt reducing shocks. Asymmetric risks are a feature of 200 years of data for the U.S. and the U.K.: rare but recurrent large surges of the debt-to-GDP ratio, followed by very gradual but persistent declines over long periods. More informal evidence from many other countries suggests that asymmetry is a general feature of fiscal shocks. The gradual smooth reduction in the public debt to GDP ratio is not a response to past developments. Instead it is optimal given recurrent fiscal risks and the empirical characteristics of fiscal shocks. The behavior of the debt-to-GDP ratio in the U.K. and the U.S. seems roughly compatible with the prescriptions of the tax-smoothing model.

Suggested Citation

  • Julio Escolano & Vitor Gaspar, 2016. "Optimal Debt Policy Under Asymmetric Risk," IMF Working Papers 16/178, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:16/178
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    1. Elva Bova & Marta Ruiz-Arranz & Frederik G Toscani & H. Elif Ture, 2016. "The Fiscal Costs of Contingent Liabilities; A New Dataset," IMF Working Papers 16/14, International Monetary Fund.
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    Cited by:

    1. repec:bla:apacel:v:33:y:2019:i:1:p:33-47 is not listed on IDEAS
    2. Luc Eyraud & Xavier Debrun & Andrew Hodge & Victor Duarte Lledo & Catherine A Pattillo, 2018. "Second-Generation Fiscal Rules; Balancing Simplicity, Flexibility, and Enforceability," IMF Staff Discussion Notes 18/04, International Monetary Fund.
    3. Ernesto Crivelli & Sanjeev Gupta & Carlos Mulas-Granados & Carolina Correa-Caro, 2016. "Fragmented Politics and Public Debt," IMF Working Papers 16/190, International Monetary Fund.
    4. repec:eee:jebusi:v:94:y:2017:i:c:p:1-14 is not listed on IDEAS
    5. Serhan Cevik, 2019. "Anchor me: the benefits and challenges of fiscal responsibility," Asian-Pacific Economic Literature, Asia Pacific School of Economics and Government, The Australian National University, vol. 33(1), pages 33-47, May.
    6. repec:pal:imfecr:v:66:y:2018:i:2:d:10.1057_s41308-018-0054-8 is not listed on IDEAS
    7. repec:col:000107:017284 is not listed on IDEAS
    8. repec:bdr:ensayo:y:2019:i:90:p:1-60 is not listed on IDEAS
    9. Serhan Cevik, 2019. "Back to the Future: Fiscal Rules for Regaining Sustainability," IMF Working Papers 19/242, International Monetary Fund.
    10. Laura Jaramillo & Carlos Mulas-Granados & Elijah Kimani, 2016. "The Blind Side of Public Debt Spikes," IMF Working Papers 16/202, International Monetary Fund.

    More about this item

    Keywords

    Debt strategy; Fiscal risk; Public debt; Debt service ratios; Debt reduction; Government Debt; Optimal Debt Policies; Fiscal Risks; Fiscal Shocks.;

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