Optimal Time-Consistent Government Debt Maturity, Fiscal Policy, and Default

Sergii Kiiashko

Journal of the European Economic Association, 2022, vol. 20, issue 5, 2062-2097

Abstract: I develop a tractable model to study the optimal debt maturity structure and fiscal policy in an environment with incomplete markets, lack of commitment, and opportunity to default by the government. I show that the Lucas and Stokey time-consistency result can be extended to environments with an opportunity of outright default. The maturity is used to resolve the time-consistency problem. I show that if both risk-free interest rates and risk premiums can be manipulated, then the optimal maturity structure tends to have a decaying profile: The government issues debt at all maturity dates, but the distribution of payments over time is skewed toward the short end. The model allows for numerical characterization of the optimal maturity structure of debt with an arbitrarily large number of maturities. Debt maturity data across countries are consistent with model predictions.

Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:oup:jeurec:v:20:y:2022:i:5:p:2062-2097.

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