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Public Debt Bubbles, Liquidity, and Risk: Policy Assessments Based on the Zero-Beta Interest Rate

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  • Narayana R. Kocherlakota

Abstract

This paper studies stationary equilibria in a novel class of analytically tractable incomplete markets models with a public debt bubble (meaning that the interest rate r̅ on riskfree government bonds is less than the growth rate). Within the models, the return rᴋ to physical capital can exceed r̅ because capital is exposed to aggregate risk and because it is less liquid than public debt. I follow di Tella et al. (2024), and define r_zero to be the zero-beta interest rate (on an asset with no aggregate risk and the same (il)liquidity properties as physical capital). I provide two distinct sufficient conditions in a zero-growth economy under which the government can increase welfare by following a fiscal policy which induces a higher r̅ . The first case is that r_zero

Suggested Citation

  • Narayana R. Kocherlakota, 2025. "Public Debt Bubbles, Liquidity, and Risk: Policy Assessments Based on the Zero-Beta Interest Rate," NBER Working Papers 33897, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:33897
    Note: AP EFG PE
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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
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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