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Government Debt Management: The Long and the Short of It

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  • Marcet, Albert
  • Scott, Andrew
  • Faraglia, Elisa
  • Oikonomou, Rigas
Abstract
Our aim is to provide insights into some basic facts of US government debt management by introducing simple financial frictions in a Ramsey model of fiscal policy. We find that the share of short bonds in total U.S. debt is large, persistent, and highly correlated with total debt. A well known literature argues that optimal debt management should behave very differently: long term debt provides fiscal insurance, hence short bonds should not be issued and the position on short debt is volatile and negatively correlated with total debt. We show that this result hinges on the assumption that governments buy back the entire stock of previously issued long bonds each year, which is very far from observed debt management. We document how the U.S. Treasury rarely has repurchased bonds before 10 years after issuance. When we impose in the model that the government does not buy back old bonds the puzzle disappears and the optimal bond portfolio matches the facts mentioned above. The reason is that issuing only long term debt under no buyback would lead to a lumpiness in debt service payments, short bonds help offset this by smoothing out interest payments and tax rates. The same reasoning helps explain why governments issue coupon-paying bonds. Solving dynamic stochastic models of optimal policy with a portfolio choice is computationally challenging. A separate contribution of this paper is to propose computational tools that enable this broad class of models to be solved. In particular we propose two significant extensions to the PEA class of computational methods which overcome problems due to the size of the model. These methods should be useful to many applications with portfolio problems and large state spaces.

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  • Marcet, Albert & Scott, Andrew & Faraglia, Elisa & Oikonomou, Rigas, 2014. "Government Debt Management: The Long and the Short of It," CEPR Discussion Papers 10281, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:10281
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    Cited by:

    1. Bouakez, Hafedh & Oikonomou, Rigas & Priftis, Romanos, 2018. "Optimal debt management in a liquidity trap," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 5-21.
    2. Equiza-Goñi, Juan & Faraglia, Elisa & Oikonomou, Rigas, 2023. "Union debt management," Journal of International Money and Finance, Elsevier, vol. 130(C).
    3. Jochen Mankart & Rigas Oikonomou, 2017. "Household Search and the Aggregate Labour Market," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 84(4), pages 1735-1788.
    4. Boris Chafwehé & Rigas Oikonomou & Romanos Priftis & Lukas Vogel, 2021. "(Optimal) Monetary Policy with and without Debt," Staff Working Papers 21-5, Bank of Canada.
    5. Alex Clymo & Andrea Lanteri & Alessandro Villa, 2023. "Capital and Labor Taxes with Costly State Contingency," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 943-964, December.
    6. George J. Hall & Thomas J. Sargent, 2015. "A History of U.S. Debt Limits," NBER Working Papers 21799, National Bureau of Economic Research, Inc.
    7. Saki Bigio & Galo Nuño & Juan Passadore, 2019. "A Framework for Debt-Maturity Management," Working Papers 143, Peruvian Economic Association.
    8. Dmitry Matveev, 2021. "Time‐Consistent Management of a Liquidity Trap with Government Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(8), pages 2129-2165, December.
    9. Alex Clymo & Andrea Lanteri, 2020. "Fiscal Policy with Limited-Time Commitment," The Economic Journal, Royal Economic Society, vol. 130(627), pages 623-652.
    10. Faraglia, E. & Marcet, A. & Oikonomou, R. & Scott, A., 2019. "A Short Note on Optimal Debt Management under Asymmetric Information," Cambridge Working Papers in Economics 1761, Faculty of Economics, University of Cambridge.
    11. Davide Debortoli & Ricardo Nunes & Pierre Yared, 2021. "Optimal Fiscal Policy without Commitment: Revisiting Lucas-Stokey," Journal of Political Economy, University of Chicago Press, vol. 129(5), pages 1640-1665.
    12. Anmol Bhandari & David Evans & Mikhail Golosov & Thomas Sargent, 2019. "The Optimal Maturity of Government Debt," 2019 Meeting Papers 1011, Society for Economic Dynamics.
    13. François Le Grand & Xavier Ragot, 2022. "Managing Inequality Over Business Cycles: Optimal Policies With Heterogeneous Agents And Aggregate Shocks," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 63(1), pages 511-540, February.
    14. Rigas Oikonomou & Albert Marcet & Elisa Faraglia, 2016. "Long term Government Bonds," 2016 Meeting Papers 565, Society for Economic Dynamics.
    15. Boris Chafwehe & Rigas Oikonomou & Romanos Priftis & Lukas Vogel, 2018. "Endogenous forward guidance," Working Paper Research 354, National Bank of Belgium.
    16. Jochen Mankart & Romanos Priftis & Rigas Oikonomou, 2022. "The long and short of financing government spending," Working Paper Research 418, National Bank of Belgium.
    17. Max Ole Liemen & Olaf Posch, 2022. "FTPL and the Maturity Structure of Government Debt in the New Keynesian Model," CESifo Working Paper Series 9840, CESifo.
    18. Philip Barrett & Christopher Johns, 2024. "Parameterizing Debt Maturity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 56(6), pages 1321-1365, September.
    19. Saki Bigio & Galo Nuño & Juan Passadore, 2023. "Debt-Maturity Management with Liquidity Costs," Journal of Political Economy Macroeconomics, University of Chicago Press, vol. 1(1), pages 119-190.
    20. Alex Clymo & Andrea Lanteri & Alessandro Villa, 2023. "Capital and Labor Taxes with Costly State Contingency," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 943-964, December.
    21. Nada Azmy Elberry & Frank Naert & Stijn Goeminne, 2023. "Optimal public debt composition during debt crises: A review of theoretical literature," Journal of Economic Surveys, Wiley Blackwell, vol. 37(2), pages 351-376, April.
    22. George J. Hall & Thomas J. Sargent, 2020. "Debt and Taxes in Eight U.S. Wars and Two Insurrections," NBER Working Papers 27115, National Bureau of Economic Research, Inc.
    23. Tianbao Zhou & Zhixin Liu & Yingying Xu, 2024. "Characterizing Public Debt Cycles: Don't Ignore the Impact of Financial Cycles," Papers 2404.17412, arXiv.org.

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    More about this item

    Keywords

    Computational methods; Debt management; Fiscal policy; Incomplete markets; Maturity structure; Tax smoothing;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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