Collaborative Research: A Unified Framework for Optimal Public Debt Management

Government debt has an important role in an economy as decisions on government debt issuance has implications on fiscal policy and the tax system. When issuing debt, government must decide on how to rebalance its existing debt, how much new debt to issue and the duration of borrowing - between short and long-term borrowing. These decisions must be made by considering the state of the economy, including the growth rate, employment levels, inflation, interest rates and the impact of government debt issuance on bond markets. The goal of this project is to develop a framework to examine current public debt management practices and suggest ways to improve them. The project will deliver easy to use and easy to implement formulas that prescribe the optimal maturity and the optimal frequency of public debt rebalancing along with mathematical models that illustrate their usefulness.

Managing public debt is a crucial policy issue that concerns economists, policymakers, and the general public. There is limited practical guidance on the types of debt securities government should issue and the frequency with which a government should rebalance its debt portfolio. This proposal aims to develop a unified framework for optimal public debt management that integrates the public debt literature that imposes commitment, the literature on debt without commitment in closed and open economies, and the finance literature on optimal portfolio theory. Methodologically, the proposal will expand the "sufficient statistics" approach that is widely used in public finance. The key deliverables will consist of formulas for optimal portfolios that summarize the normative prescriptions from large classes of models in terms of a small number of empirical moments. These moments will be estimated and used as inputs in a quantitative structural model of debt management that can be used for joint analysis of debt and tax policies.