Managing Debt Stability

Emanuele Bacchiocchi and Alessandro Missale

No 1388, CESifo Working Paper Series from CESifo

Abstract: This paper presents a simple model in which debt management stabilizes the debt-to-GDP ratio in face of shocks to real returns and output growth and thus supports fiscal restraint in ensuring sustainability. The optimal composition of public debt is derived by looking at the relative impact of the risk and cost of alternative debt instruments on the cost of missing the stabilization target. The optimal debt structure is a function of the expected return differentials between debt instruments, of the conditional variance of their returns and of the conditional covariances of their returns with output growth and inflation. We then explore how the relevant covariances and thus the optimal choice of debt instruments depend on the monetary regime and on Central Bank preferences for output stabilization, inflation control and interest-rate smoothing. Finally, we estimate the composition of public debt that would have supported debt stabilization in OECD countries over the last two decades. The empirical evidence suggests that the public debt should have a long maturity and a large share of it should be indexed to the price level.

Keywords: debt management; debt structure; debt stabilization; inflation indexation; interest rates (search for similar items in EconPapers)
Date: 2005
New Economics Papers: this item is included in nep-cfn, nep-mac and nep-pbe
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Citations: View citations in EconPapers (11)

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Working Paper: Managing debt stability (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_1388

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