--%>

Comparative-Advantage Approach to Government Debt Maturity

We study optimal government debt maturity in a model where investors derive monetary servicesfrom holding riskless short-term securities. In a simple setting where the government is the onlyissuer of such riskless paper, it trades off the monetary premium associated with short-term debtagainst the refinancing risk implied by the need to roll over its debt more often. We then extend themodel to allow private financial intermediaries to compete with the government in the provision ofmoney-like claims. We argue that if there are negative externalities associated with private moneycreation, the government should tilt its issuance more towards short maturities. The idea is that thegovernment may have a comparative advantage relative to the private sector in bearing refinancingrisk, and hence should aim to partially crowd out the private sector's use of short-term debt. 

In this paper, we study the question of how the government should optimally determine thematurity structure of its debt. We focus on situations where there is no question about thegovernment's ability to service its obligations, so the analysis should be thought of as applying tocountries like the U.S. that are seen to be of high credit quality.1 The primary novelty of our approachis that we emphasize the monetary benefits that investors derive from holding riskless securities, suchas short-term Treasury bills. These benefits lead T-bills to embed a convenience premium, i.e., tohave a lower yield than would be expected from a traditional asset-pricing model. 

We begin with the case where the government is the only entity able to create riskless moneylikesecurities. In this case, optimal debt maturity turns on a simple tradeoff. On the one hand, as thegovernment tilts its issuance to shorter maturities, it generates more in the way of monetary servicesthat are socially valuable; this is reflected in a lower expected financing cost. On the other hand, astrategy of short-term financing also exposes the government to rollover risk, given that futureinterest rates are unpredictable. As a number of previous papers have observed, such rollover riskleads to real costs insofar as it makes future taxes more volatile. 

This tradeoff yields a well-defined interior optimum for government debt maturity, unliketraditional tax-smoothing models which imply that government debt should be very long term. It alsoimplies a number of comparative statics that are borne out in the data. Most notably, it predicts thatgovernment debt maturity will be positively correlated with the ratio of government debt to GDP, apattern which emerges strongly in U.S. data. The intuition is that as the aggregate debt burden grows,the costs associated with rollover risk-and hence with failing to smooth taxes-loom larger. 

The simple tradeoff model also captures the way in which Treasury and Federal Reservepractitioners have traditionally framed the debt-maturity problem. According to former TreasurySecretary Lawrence Summers: 

   Related Questions in Managerial Accounting

  • Q : Selecting strategic options and

    Write a short note on selecting strategic options and formulating the plans?

  • Q : Tax form a deadweight loss Why does a

    Why does a tax form a deadweight loss? A tax forms deadweight loss by artificially increasing price above the free market level, therefore reducing the equilibrium quantity. This reduction in demand decreases consumer as well as producer surplu

  • Q : Define Employee Stock Ownership

    Employee Stock Ownership: It is a qualified, defined contribution, employee benefit (that is, ERISA) plan designed to invest mainly in the stock of sponsoring employer. ESOPs are "qualified" in the logic that the ESOP's sponsoring company, the selling

  • Q : Define Job Costing Job Costing : It is

    Job Costing: It is an order-specific costing method, utilized in situations where each job is distinct and is executed to the customer's specifications. Job costing includes keeping an account of direct and in-direct costs.

    Q : Management accounting According to

    According to Martin and Steele (2010, p.13), “The two principal professional associations in Australia – CPA Australia (the CPA) and the Institute of Chartered Accountants in Australia (the Institute) have indicated their awareness of the significance of issues of sustainability reporting and develo

  • Q : Explain Cost Allocation Cost Allocation

    Cost Allocation: This is a technique of assigning costs to activities, outputs, or other cost objects. The allocation base employed to assign a cost to objects is not essentially the cause of the cost. For illustration, assigning the

  • Q : Reaping the benefits of IT What do you

    What do you mean by the term reaping the benefits of IT? Explain n brief?

  • Q : Provision of management accounting

    What do you mean by the term provision of management accounting information?

  • Q : Features of the management accounting

    What are the various features of the management accounting information system?

  • Q : Explain Cost or Benefit Analysis Cost

    Cost or Benefit Analysis: The Cost-benefit analysis (abbreviated as CBA) is an analytical device for assessing and pros and cons of moving forward with the business proposal. It is a process by which business decis