Events at CERGE-EI

Dallal Bendjellal, MSc.

Aix-Marseille School of Economics, France

Abstract: What debt maturities should governments issue when sovereign bonds serve as collateral? Standard Debt Management frameworks advocate for the issuance of long-term debt because of its hedging benefits for the government’s budget. These frameworks are premised on the assumption that public debt is solely used to finance fiscal deficits. In practice, government bonds play a central role in financial markets as they are used as collateral to borrow liquidity. This paper introduces the collateral role of public debt into a standard Debt Management model to analyze its impact on the optimal structure of debt maturity. My main finding is that optimal maturity management involves an additional objective which is the provision of collateral and thus liquidity. This raises a policy trade-off for the government. While long-term debt allows to reduce the debt borrowing costs, short-term debt proves more effective to enhance liquidity provision. I show that the optimal maturity structure depends on the extent to which private liquidity relies on collateral. For a plausible calibration, the government finds it optimal to issue short-term bonds to accommodate liquidity provision.

JEL Classification: E62, H63, H21, G18, D53
Keywords: Debt Management, Maturity Structure, Collateral, Financial Frictions

Full Text: Public Debt Maturity: The Role of Liquidity Provision