Optimal Debt Policy Under Asymmetric Risk
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Summary:
In the paper we show that, most of the time, smooth reduction in the debt ratio is optimal for tax-smoothing purposes when fiscal risks are asymmetric, with large debt-augmenting shocks more likely than commensurate debt reducing shocks. Asymmetric risks are a feature of 200 years of data for the U.S. and the U.K.: rare but recurrent large surges of the debt-to-GDP ratio, followed by very gradual but persistent declines over long periods. More informal evidence from many other countries suggests that asymmetry is a general feature of fiscal shocks. The gradual smooth reduction in the public debt to GDP ratio is not a response to past developments. Instead it is optimal given recurrent fiscal risks and the empirical characteristics of fiscal shocks. The behavior of the debt-to-GDP ratio in the U.K. and the U.S. seems roughly compatible with the prescriptions of the tax-smoothing model.
Series:
Working Paper No. 2016/178
Subject:
Asset and liability management Debt reduction Expenditure Fiscal policy Fiscal stance Global financial crisis of 2008-2009 Public debt Revenue administration
English
Publication Date:
August 26, 2016
ISBN/ISSN:
9781475529845/1018-5941
Stock No:
WPIEA2016178
Pages:
21
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