Manufacturing Risk-free Government Debt
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.
Related
Topics
Programs
More from NBER
In addition to working papers, the NBER disseminates affiliates’ latest findings through a range of free periodicals — the NBER Reporter, the NBER Digest, the Bulletin on Retirement and Disability, the Bulletin on Health, and the Bulletin on Entrepreneurship — as well as online conference reports, video lectures, and interviews.
