Faraglia, E., Marcet, A., Oikonomou, R. and Scott, A.

Government Debt management: the Short and the Long of it

Review of Economic Studies

Vol. 86(6) pp. 2554–2604 (2019)

Abstract: Standard optimal Debt Management (DM) models prescribe a dominant role for long bonds and advocate against issuing short bonds. They require very large positions in order to complete markets and assume each period that governments repurchase all outstanding bonds and reissue (r/r) new ones. These features of DM are inconsistent with U.S. data. We introduce incomplete markets via small transaction costs which serves to make optimal DM more closely resemble the data : r/r are negligible, short bond issuance substantial and persistent and short and long bonds positively co-vary. Intuitively, long bonds help smooth taxes over states and short bonds over time. Solving incomplete market models with multiple assets is challenging so a further contribution of this article is introducing a novel computational method to find global solutions.

Keywords: Bond repurchases, Computational methods, Debt management, Fiscal policy, Incomplete markets, Maturity structure, Tax smoothing

JEL Codes: C63, E43, E62, H63

Author links: Elisa Faraglia  

Publisher's Link: https://doi.org/10.1093/restud/rdy061