Manufacturing Risk-Free Government Debt

65 Pages Posted: 11 Sep 2020 Last revised: 12 Feb 2022

See all articles by Zhengyang Jiang

Zhengyang Jiang

Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER)

hlustig@stanford.edu Lustig

Stanford University

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); ABFER

Mindy Z. Xiaolan

University of Texas, Austin - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: September 2020

Abstract

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.

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Suggested Citation

Jiang, Zhengyang and Lustig, hlustig@stanford.edu and Van Nieuwerburgh, Stijn and Xiaolan, Mindy Z., Manufacturing Risk-Free Government Debt (September 2020). NBER Working Paper No. w27786, Available at SSRN: https://ssrn.com/abstract=3687942

Zhengyang Jiang (Contact Author)

Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

HOME PAGE: http://sites.google.com/site/jayzedwye/

National Bureau of Economic Research (NBER) ( email )

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Hlustig@stanford.edu Lustig

Stanford University

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Mindy Z. Xiaolan

University of Texas, Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

HOME PAGE: http://sites.google.com/view/mindyxiaolan

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