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

Narayana Kocherlakota

No 33897, NBER Working Papers from National Bureau of Economic Research, Inc

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

JEL-codes: E62 G12 (search for similar items in EconPapers)
Date: 2025-06
Note: AP EFG PE
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