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Optimal Public Debt Management and Liquidity Provision

  • George-Marios Angeletos
  • Fabrice Collard
  • Harris Dellas
  • Behzad Diba

We study the Ramsey policy problem in an economy in which firms face a collateral constraint. Issuing more public debt alleviates this friction by increasing the aggregate quantity of collateral. In so doing, however, the issuance of more debt also raises interest rates, which in turn increases the tax burden of servicing the entire outstanding debt. We first document how this trade-off upsets the optimality of tax smoothing and, in contrast to the standard paradigm, helps induce a unique and stable steady-state level of debt in the deterministic version of the model. We next study the optimal policy response to fiscal and financial shocks in the stochastic version. We finally show how the results extend to a variant model in which the financial friction afflicts consumers rather than firms.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18800.

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Date of creation: Feb 2013
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Handle: RePEc:nbr:nberwo:18800
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  1. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  2. Xavier Ragot & Edouard Challe, 2011. "Fiscal Policy in a Tractable Liquidity-Constrained Economy," Post-Print halshs-00654650, HAL.
  3. Aubhik Khan & Julia K. Thomas, 2011. "Credit Shocks and Aggregate Fluctuations in an Economy with Production Heterogeneity," NBER Working Papers 17311, National Bureau of Economic Research, Inc.
  4. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  5. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  6. Emmanuel Farhi, 2007. "Capital Taxation and Ownership when Markets are Incomplete," NBER Working Papers 13390, National Bureau of Economic Research, Inc.
  7. Francisco J. Buera & Benjamin Moll, 2012. "Aggregate Implications of a Credit Crunch," NBER Working Papers 17775, National Bureau of Economic Research, Inc.
  8. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
  9. Fabrice Collard & Harris Dellas & Behzad Diba & Olivier Loisel, 2012. "Optimal Monetary and Prudential Policies," Working Papers 2012-34, Centre de Recherche en Economie et Statistique.
  10. S. Rao Aiyagari & Ellen R. McGrattan, 1994. "The optimal quantity of debt," Working Papers 538, Federal Reserve Bank of Minneapolis.
  11. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  12. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
  13. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
  14. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2012. "The Aggregate Demand for Treasury Debt," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 233 - 267.
  15. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, Oxford University Press, vol. 127(3), pages 1469-1513.
  16. Guido Lorenzoni & Veronica Guerrieri, 2011. "Credit Crises, Precautionary Savings and the Liquidity Trap," 2011 Meeting Papers 1414, Society for Economic Dynamics.
  17. Oliver Hart & John Moore, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 841-879.
  18. George-Marios Angeletos, 2002. "Fiscal Policy with Noncontingent Debt and the Optimal Maturity Structure," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 1105-1131.
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