Public Debt as Private Liquidity: Optimal Policy

Abstract

We study optimal policy in an economy where interest rates are low because public debt serves as collateral or buffer stock. Issuing more public debt raises welfare by easing the underlying friction but also reduces the private valuation of this service, raising interest rates. This trade-off shapes the optimal quantity of public debt in the long run, justifies a departure from tax smoothing in the short run, and calls for larger deficits during financial crises. Our analysis illustrates the possible robustness of these insights to different microfoundations and helps clarify when exactly low interest rates represent an opportunity for cheap government borrowing.

Replaces

George-Marios Angeletos, Fabrice Collard, and Harris Dellas, “Public Debt as Private Liquidity: Optimal Policy”, TSE Working Paper, n. 11-1170, December 2020.

Reference

George-Marios Angeletos, Fabrice Collard, and Harris Dellas, “Public Debt as Private Liquidity: Optimal Policy”, Journal of Political Economy, vol. 131, n. 11, November 2023.