NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Optimal Public Debt Management and Liquidity Provision

George-Marios Angeletos, Fabrice Collard, Harris Dellas, Behzad Diba

NBER Working Paper No. 18800
Issued in February 2013
NBER Program(s):   EFG   ME

We study the Ramsey policy problem in an economy in which firms face a collateral constraint. Issuing more public debt alleviates this friction by increasing the aggregate quantity of collateral. In so doing, however, the issuance of more debt also raises interest rates, which in turn increases the tax burden of servicing the entire outstanding debt. We first document how this trade-off upsets the optimality of tax smoothing and, in contrast to the standard paradigm, helps induce a unique and stable steady-state level of debt in the deterministic version of the model. We next study the optimal policy response to fiscal and financial shocks in the stochastic version. We finally show how the results extend to a variant model in which the financial friction afflicts consumers rather than firms.

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Document Object Identifier (DOI): 10.3386/w18800

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