Optimal Debt Policy Under Asymmetric Risk

Author/Editor:

Julio Escolano ; Vitor Gaspar

Publication Date:

August 26, 2016

Electronic Access:

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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. 16/178

Subject:

English

Publication Date:

August 26, 2016

ISBN/ISSN:

9781475529845/1018-5941

Stock No:

WPIEA2016178

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

21

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