The Optimal Maturity of Government Debt
AbstractA Ramsey planner chooses a distorting tax on labor and manages a portfolio of
bonds of different maturities in a representative agent economy with aggregate shocks.
Covariances of bonds’ returns with the primary deficit are key determinants of Ramsey
portfolios. We estimate these moments in U.S. data and calibrate a model with a
representative agents who has Epstein-Zin preferences that matches these moments.
The implied optimal portfolio does not short any bond and allocates approximately
equal portfolio shares to bonds of different maturities, slightly tilt towards longer
maturities when the outstanding debt is large, and requires little re-balancing in
response to aggregate shocks. These portfolio prescriptions differ from those of models
often used in the business cycle literature. The differences are driven by counterfactual
asset pricing implications of the standard models.