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Manufacturing Risk-free Government Debt

Author

Listed:
  • Zhengyang Jiang
  • Hanno Lustig
  • Stijn Van Nieuwerburgh
  • Mindy Z. Xiaolan
Abstract
Governments face a trade-off between insuring bondholders and insuring taxpayers against output risk. If they insure bondholders by manufacturing risk-free zero-beta debt, then their capacity to insure taxpayers by lowering tax rates or raising government spending during recessions is limited. Using asset pricing tools, we develop a sufficient statistic for taxpayer insurance possibilities over different horizons, and characterize it analytically as a function of the debt/output, spending/output, and pricing kernel dynamics. With permanent shocks, taxpayers can only be insured over short horizons through counter-cyclical debt issuance. The horizon shrinks as the debt/output ratio reverts faster to its mean. The trade-off worsens if the output shocks are transitory instead of permanent. As the world’s safe asset supplier, the U.S. relies on strongly counter-cyclical debt issuance to provide more short-run insurance to its taxpayers.

Suggested Citation

  • Zhengyang Jiang & Hanno Lustig & Stijn Van Nieuwerburgh & Mindy Z. Xiaolan, 2020. "Manufacturing Risk-free Government Debt," NBER Working Papers 27786, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:27786
    Note: AP EFG IFM ME PE
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    References listed on IDEAS

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    Cited by:

    1. Debrun, Xavier & Masuch, Klaus & Ferrero, Guiseppe & Vansteenkiste, Isabel & Ferdinandusse, Marien & von Thadden, Leopold & Hauptmeier, Sebastian & Alloza, Mario & Derouen, Chloé & Bańkowski, Krzyszto, 2021. "Monetary-fiscal policy interactions in the euro area," Occasional Paper Series 273, European Central Bank.
    2. Van Nieuwerburgh, Stijn & Elenev, Vadim & Landvoigt, Tim & Shultz, Patrick, 2021. "Can Monetary Policy Create Fiscal Capacity?," CEPR Discussion Papers 16414, C.E.P.R. Discussion Papers.
    3. Corhay, Alexandre & Kind, Thilo & Kung, Howard & Morales, Gonzalo, 2021. "Discount rates, debt maturity, and the fiscal theory," SAFE Working Paper Series 323, Leibniz Institute for Financial Research SAFE.
    4. Chien, YiLi & Wen, Yi, 2022. "The determination of public debt under both aggregate and idiosyncratic uncertainty," Journal of Economic Theory, Elsevier, vol. 203(C).
    5. Jiang, Zhengyang, 2021. "US Fiscal cycle and the dollar," Journal of Monetary Economics, Elsevier, vol. 124(C), pages 91-106.

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    More about this item

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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