| Abstract: |
This paper develops a model of optimal government debt maturity in which the
government cannot issue state-contingent bonds and cannot commit to fiscal
policy. If the government can perfectly commit, it fully insulates the economy
against government spending shocks by purchasing short-term assets and issuing
long-term debt. These positions are quantitatively very large relative to GDP
and do not need to be actively managed by the government. Our main result is
that these conclusions are not robust to the introduction of lack of
commitment. Under lack of commitment, large and tilted positions are very
expensive to finance ex-ante since they exacerbate the problem of lack of
commitment ex-post. In contrast, a flat maturity structure minimizes the cost
of lack of commitment, though it also limits insurance and increases the
volatility of fiscal policy distortions. We show that the optimal maturity
structure is nearly flat because reducing average borrowing costs is
quantitatively more important for welfare than reducing fiscal policy
volatility. Thus, under lack of commitment, the government actively manages
its debt positions and can approximate optimal policy by confining its debt
instruments to consols. |