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Managing debt stability

  • Alessandro MISSALE

    ()

  • Emanuele BACCHIOCCHI

    ()

This paper presents a simple model in which debt management stabilizes the debt-to-GDP ratio in face of shocks to real returns and output growth and thus supports fiscal restraint in ensuring sustainability. The optimal composition of public debt is derived by looking at the relative impact of the risk and cost of alternative debt instruments on the cost of missing the stabilization target. The optimal debt structure is a function of the expected return differentials between debt instruments, of the conditional variance of their returns and of the conditional covariances of their returns with output growth and inflation. We then explore how the relevant covariances and thus the optimal choice of debt instruments depend on the monetary regime and on Central Bank preferences for output stabilization, inflation control and interest-rate smoothing. Finally, we estimate the composition of public debt that would have supported debt stabilization in OECD countries over the last two decades. The empirical evidence suggests that the public debt should have a long maturity and a large share of it should be indexed to the price level

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Paper provided by Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano in its series Departmental Working Papers with number 2005-05.

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Date of creation: 01 Jan 2005
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Handle: RePEc:mil:wpdepa:2005-05
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  1. Missale, Alessandro, 1997. " Managing the Public Debt: The Optimal Taxation Approach," Journal of Economic Surveys, Wiley Blackwell, vol. 11(3), pages 235-65, September.
  2. Bohn, Henning, 1988. "Why do we have nominal government debt?," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 127-140, January.
  3. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-30, December.
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