Journal of Political Economy Vol. 131 No. 11 2023

Public Debt as Private Liquidity: Optimal Policy

George‐Marios Angeletos^1,2; Fabrice Collard^3,4; Harris Dellas^5,6

¹ Northwestern University · ² MIT Department of Economics · ³ Centre National pour la Recherche Scientifique et Technique (CNRST) · ⁴ Toulouse School of Economics · ⁵ University of Bern · ⁶ Federal Reserve Bank of St. Louis

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.

DOI

10.1086/725170

Volume

131

Issue

11

Pages

3233-3264

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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