Public Debt as Private Liquidity: Optimal Policy

Résumé 0

We study optimal policy in an economy in which public debt serves as collateral or buffer stock. Issuing more public debt can raise welfare by easing the underlying friction; but it also reduces the premium that the private sector is willing to pay for this service, which in turn raises interest rates. This trade off shapes the optimal long-run quantity of public debt. It justifies larger deficits during financial crises. It may subsume other considerations, such as whether public debt crowds out, or in, capital. And it clarifies the circumstances under which a low risk-free rate represents an opportunity of cheap borrowing by the government. * This paper supersedes an earlier paper, entitled "Optimal Public Debt Management and Liquidity Provision" (Angeletos et al, 2016). We are grateful to Behzad Diba for his collaboration on the early stages of this project; to Pedro Teles and Per Krusell for discussing our paper in conferences; to numerous seminar participants for their comments; and, last but not certainly not least, to Harald Uhlig and three anonymous for their extensive feedback. Angeletos also thanks the University of Bern, the Study Center Gerzensee, and the Swiss Finance Institute for their hospitality.