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Title: Public Debt as Private Liquidity: Optimal Policy

Author(s): George-Marios Angeletos, Fabrice Collard and Harris Dellas

Publication Date: November 2020

Keyword(s): optimal policy, piblic debt and private liquidity

Programme Area(s): Macroeconomics and Growth

Abstract: We study optimal policy in an economy in which public debt is used as collateral or liquidity buffer. Issuing more public debt raises welfare by easing the underlying financial friction; but this easing lowers the liquidity premium and increases the government's cost of borrowing. These considerations, which are absent in the basic Ramsey paradigm, help pin down a unique, long-run level of public debt. They require a front-loaded tax response to government-spending shocks, instead of tax smoothing. And they explain why a financial recession, more than a traditional one, makes government borrowing cheaper, optimally supporting larger fiscal stimuli.

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Bibliographic Reference

Angeletos, G, Collard, F and Dellas, H. 2020. 'Public Debt as Private Liquidity: Optimal Policy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=15488