Sovereign deb managemen and fiscal vulnerabiliies Alessandro Missale 1 Absrac A wide consensus has emerged on he role of deb managemen in reducing fiscal vulnerabiliy by providing insurance agains macroeconomic shocks o he governmen budge. Wheher his goal is beer accomplished by nominal or inflaion-indexed deb, by a shor or a long mauriy srucure, remains however conroversial. In his paper we review he issues of indexaion and deb mauriy, discussing in paricular he role of he mauriy srucure in ligh of inegraed financial markes and he risk of defaul. We argue ha he role of inflaion-indexed deb as a hedge agains demand and inflaion shocks is less imporan when price sabiliy is ensured by a Ricardian fiscal policy and an independen cenral bank. A srong case can insead be made for a long mauriy srucure o reduce ineres-rae risk and, more imporanly, he risk of defaul. The mauriy of he deb is a key variable o assess he vulnerabiliy of he governmen fiscal posiion and should deserve greaer aenion in deb susainabiliy analysis. Finally, we compare he heory of fiscal insurance o he deb managers pracice of minimizing he cos and risk of he ineres expendiure. A concern for he cos of deb service is jusified only if expeced reurn differenials beween deb insrumens are deermined by mispricing, marke imperfecions or liquidiy, bu no if higher risk premia reflec a fair price for insurance. Our analysis poins o he danger of minimizing he ineres expendiure over a shor horizon as may happen in imes of crisis, when he governmen srives o achieve budge balance. More generally, fiscal insurance canno be evaluaed using naional accouns figures, such as he ineres expendiure and he book value of he deb. The lack of a more heory-based accouning framework is indeed a major obsacle o opimal deb managemen. Keywords: Deb managemen, defaul risk, inflaion-indexed deb, mauriy srucure, ineresrae risk, opimal axaion JEL classificaion: E61, G12, H63 1 Alessandro Missale, DEAS, Universià degli Sudi di Milano, Via Conservaorio 7, 20122 Milano, Ialy. Tel. +39250321512, Fax +39250321505. E-mail: alessandro.missale@unimi.i BIS Papers No 65 157
1. Inroducion How should he deb be managed? Tweny years ago, he lieraure on deb managemen was small, made of few, imporan bu unrelaed conribuions. 2 Cerainly, here was no unique answer o wha he objecives of deb managemen should be. A wide consensus has now emerged on he role of deb managemen in reducing fiscal vulnerabiliy by providing insurance agains macroeconomic shocks o he governmen budge. The deb should be managed o make he fiscal posiion resilien o shocks and hus avoid he risk of having o adjus ax raes or cu governmen programmes (Bohn 1988, 1990, Missale 1997, 1999). Faraglia, Marce and Sco (2008) have named his approach he fiscal insurance heory of deb managemen. While his approach is no new, as i is rooed in he opimal axaion heory, fiscal insurance is a beer erm o encompass he poenial goals of deb managemen. Indeed, as called for by opimal axaion, a deb srucure ha provides a hedge agains shocks o he budge allows policy makers o minimize variaions in ax raes and hus he welfare losses of ax disorions. Bu, he insurance ha he deb srucure can offer is no only valuable for ax smoohing; i helps achieve oher imporan objecives of fiscal policy. For insance, by sabilizing he deb-o-gdp raio, fiscal insurance enhances deb susainabiliy (Lloyd-Ellis and Zhu 2001, Borenzsein and Mauro 2004, Giavazzi and Missale 2005). The immunizing deb srucure also works as an auomaic sabilizer: i avoids higher ax raes in bad imes, hus prevening axaion from being pro-cyclical, consisen wih he Keynesian view of fiscal policy. Finally, as insurance is provided by deb holders o axpayers, he deb-ax scheme implemens an allocaion of risk ha appears desirable in ha deb holders are in a beer posiion o wihsand risk, if anyhing because axes are compulsory while deb holdings are volunary (Missale 1999). I is hen clear ha deb managemen is crucial for fiscal policy o aain imporan macroeconomic objecives and hus canno be confined o porfolio opimizaion, which is ofen he focus of Deb Managemen Offices. Indeed, according o he heory of fiscal insurance, deb managemen is inseparable from fiscal policy in ha he deb srucure affecs he disribuion of ax raes over ime and across saes of naure. Alhough he opimal axaion lieraure has increasingly focused on he role of deb mauriy in real economies where governmens are able o commi o a susainable pah of fuure axes, earlier sudies dealing wih he ime inconsisency of axaion also addressed he ineracion beween deb managemen and moneary policy. In a closed economy wihou capial, Lucas and Sokey (1983) showed ha wihou a proper mauriy srucure ineremporal ax changes, by alering he equilibrium allocaion of consumpion, could affec real ineres raes and hus he value of he deb. They also showed ha, in a moneary economy, he inabiliy o commi o a fuure ax plan even prevens he governmen from issuing nominal deb because of he incenive o wipe ou is real value wih a price level jump so as o dispose of disorionary axaion. The susainabiliy of fiscal policy, ie he governmen s abiliy o commi o a credible pah of fuure surpluses, is indeed crucial for moneary policy o conrol inflaion and nominal ineres raes. As emphasized by he fiscal heory of he price level, if fiscal policy is Non-Ricardian, he price level and nominal ineres raes are deermined by he expeced primary surpluses, he level of nominal deb (Leeper 1991, Woodford 1994, 1995) and is mauriy srucure (Cochrane 2001). The denominaion and mauriy of public deb may also aler he incenives faced by he moneary auhoriy. Because of inflaionary empaions, domesic currency -nominal- deb 2 Earlier conribuions include Tobin (1963), Fischer (1983), Lucas and Sokey (1983), Bohn (1988) and are surveyed in Missale (1997). 158 BIS Papers No 65
may lead o inflaionary expecaions and hus higher nominal ineres raes as firs shown by Calvo (1988). Then, foreign currency deb or shor mauriies are needed o resore he credibiliy of he ani-inflaionary policy (Missale and Blanchard 1994). The ime-consisency lieraure has provided he heoreical underpinning for he decision o delegae moneary policy o independen cenral banks wih a clear mandae for price sabiliy since he mid-1980s in advanced economies and, more recenly, in emerging counries. The effecive independence of moneary policy was hen suppored by pledges of fiscal responsibiliy, as winessed by he adopion of fiscal rules in many counries. In urn, cenral bank independence was insrumenal in shifing he deb composiion o domesic currency fixed-rae deb and lenghening is mauriy srucure as shown by Falcei and Missale (2002). The separaion of deb managemen from moneary policy was also favoured by he removal of capial conrols and financial liberalizaion. As ineres raes had been deermined in inernaionally inegraed financial markes wih no role, if any before, for changes in he relaive supply of domesic securiies, he coordinaion of deb managemen and moneary policy was considered no an issue anymore. The separaion of deb managemen from moneary policy worked well and remained undispued unil he global financial crisis, when we enered a new era of fiscal dominance as argued by Turner (2011) and Blommesein and Turner (2012). Research on deb managemen over he las decade has been influenced by moneary policy independence (and is abiliy o conrol inflaion) in ha he opimal deb composiion for fiscal insurance has been invesigaed wihin real economies (wih no disincion beween real and nominal bonds) under susainable deb pahs guaraneed by he assumpion of deb limis or expeced primary surpluses saisfying he No-Ponzi game condiion. On he oher hand, financial inegraion and he increasing imporance of global facors in deermining long-erm ineres raes have no been accouned for by models ha remained focused on closed economies. Anoher serious obsacle for he implemenaion of fiscal insurance is ha economic heory and pracical policy refer o differen conceps. Indeed, heory and policy speak differen languages: while he former focuses on he marke value of he deb and raes of reurn, policy makers are concerned wih naional accouning figures; he book value of he deb and he ineres paymens (Hall and Sargen 2011). I is hen no surprising ha he fiscal insurance approach sill offers a limied guidance o policy makers. Based on sound economic principles, fiscal insurance provides general prescripions bu offers no precise indicaion regarding he ype of bonds o be issued and heir mauriy. While he benefis of fiscal insurance are undispued, wheher his goal is beer accomplished by nominal or inflaion-indexed deb, by a shor or a long mauriy srucure, remains conroversial. In he firs par of his paper we review he issues of price indexaion and deb mauriy, discussing in paricular he choice of he mauriy srucure in ligh of inegraed financial markes and he risk of defaul. We argue ha he role of inflaion-indexed deb as a hedge agains demand shocks or inflaion shocks loses much of is imporance if price sabiliy is ensured by a Ricardian fiscal policy and an independen cenral bank. A srong case for long mauriy deb can insead be made o reduce ineres-rae risk and, more imporanly, he risk of defaul when a Non-Ricardian policy regime is enered ino due o a sudden shif in expecaions driven by marke senimen. In he second par of he paper, we relae he fiscal insurance heory o policy pracice, discuss heir differen objecives and examine wheher hey can be reconciled. In paricular, we compare he policy implicaions from fiscal insurance wih he deb managers pracice of minimizing he cos and risk of he ineres expendiure. We find ha a rade-off beween cos and risk emerges only if expeced reurn differenials are deermined by mispricing, marke imperfecions and liquidiy, bu no when higher risk premia reflec a fair price for insurance. Our analysis poins o he danger of minimizing he coss and risks of he ineres expendiure BIS Papers No 65 159
over a shor ime horizon. The excessive role played by curren deficis in he evaluaion of fiscal performance and in fiscal rules may lead o subopimal deb sraegies in imes of crisis, when he governmen srives o achieve budge balance. Fiscal insurance canno be evaluaed on he basis of naional accouns figures, such as he ineres expendiure and he book value of he deb. The lack of a more heory-based accouning framework is indeed a major obsacle o opimal deb managemen. The paper is organized as follows. Afer his Inroducion, Secion 2 deals wih he absence of explicily coningen deb. Secion 3 reviews he main argumens for and agains inflaionindexed deb. Secion 4 invesigaes he role of deb mauriy in providing insurance agains macroeconomic shocks and he risk of defaul. Secion 5 examines how he deb is managed in pracice and wheher i is managed in a way consisen wih fiscal insurance. Secion 6 concludes. 2. The fiscal insurance heory of deb managemen A wide consensus has emerged on he role of deb managemen in reducing fiscal vulnerabiliy by providing insurance agains macroeconomic shocks affecing he governmen budge. The idea of fiscal insurance is innae in he heory of opimal axaion, in ha a deb srucure ha provides a hedge agains macroeconomic shocks o he budge can suppor a relaively consan ax rae over ime and across saes of naure. Tax smoohing is desirable because i allows policy makers o reduce he welfare losses from ax disorions under realisic assumpions abou he elasiciy of labour supply and oher ax bases (Chari, Chrisiano and Kehoe 1994). To reduce fiscal vulnerabiliy, and hus he risk of having o adjus ax raes or cu spending programmes, he governmen should issue deb insrumens wih reurns ha covary negaively wih governmen consumpion and posiively wih he ax base, say, oupu and aggregae consumpion. As firs shown by Lucas and Sokey (1983), wih complee markes his can be accomplished by issuing deb insrumens ha are explicily coningen on he shocks affecing he governmen budge, for insance by issuing deb negaively indexed o expendiure shocks and/or posiively indexed o oupu (Shiller 1993, Barro 1995, Borenzsein and Mauro 2004). 2.1 Explicily coningen deb: why does i no exis? Economic recessions and governmen spending shocks due, for example, o naural disasers are main sources of fiscal vulnerabiliy. The lack of insurance agains such evens is, a firs glance, puzzling. Why do governmens no issue bonds explicily coningen on heir spending or GDP? Moral hazard is he obvious answer for he absence of spending indexaion (Bohn 1990, Calvo and Guidoi 1990). The lack of GDP-indexed bonds canno insead be explained by adverse incenive effecs, and deserves furher discussion. 3 Issuance of GDP-indexed bonds runs ino various difficulies. A firs problem is he delay wih which esimaes of GDP become available and heir laer, someimes subsanial, revisions. A second problem regards he complexiy of he insrumen ha makes is pricing a difficul business. When liquidiy is added o he lis, i becomes immediaely eviden why governmens have no even considered he inroducion of such bonds. In fac, he cos of innovaing migh be subsanial. Among he few experimens wih GDP indexaion i is worh 3 GDP-indexed bonds have been advocaed, among ohers, by Shiller (1993), Borenzsein and Mauro (2004), Griffih-Jones and Sharma (2006), Kamsra and Shiller (2010). 160 BIS Papers No 65
recalling he offer of GDP warrans on he resrucured Argenine deb in 2005. Since he warran was barely valued a he ime of issuance, while GDP growh urned ou srong in he following years, sizeable losses were experienced by he Argenine governmen. However, illiquidiy and unconvenionaliy (on which pricing problems depend) could jus be an equilibrium phenomenon ha a srong move oward real indexaion could possibly overcome. This suggess ha GDP indexaion should arac more aenion from researchers and deb managers. 3. Fiscal insurance: nominal versus inflaion-indexed deb A main resul in he lieraure on deb managemen is ha explicily coningen securiies are no needed for fiscal insurance (Bohn 1988, 1990). When markes are incomplee and he governmen has only convenional deb a is disposal, ax adjusmens can be avered by issuing securiies ha offer low reurns in bad saes of naure, when oupu is lower and governmen consumpion higher han expeced. Nominal bonds, being implicily coningen on he realizaion of he price level, can provide insurance agains shocks ha lead o a negaive correlaion beween unexpeced inflaion and oupu or o a posiive correlaion beween unexpeced inflaion and governmen consumpion; ha is, when inflaion covaries posiively wih governmen financing needs. Wheher inflaion-indexed or convenional deb provides he bes hedge agains budge risk hus depends on he ypes of shocks hiing he economy, in paricular on wheher supply or demand shocks are expeced o prevail. For insance, inflaion-indexed bonds provide insurance agains negaive demand shocks bu amplify he budge coss of negaive supply shocks. 4 Unforunaely, empirical research may offer limied guidance as o he choice of nominal versus inflaion-indexed deb as he opimal mix appears o depend on he counries and ime periods considered. 5 More imporan, nohing guaranees ha he same shocks ha occurred in he pas will repea in he fuure. The lack of knowledge abou he ype of shocks affecing he economy suggess porfolio diversificaion as an argumen for issuing some inflaion-indexed deb. On he oher hand, cos consideraions may favour convenional deb. In fac, he posiive differenial beween expeced and break-even inflaion ha is ofen observed especially a he sar of indexaion programmes suggess ha indexed bonds pay a sizeable premium over nominal bonds. 6 Sack and Elsasser (2004) find ha he US Treasury paid ineres on TIPs of abou 20 basis poins higher han on convenional bonds. 7 According o TBAC (2008), he esimaed cumulaive losses on inflaion-indexed deb reached 30 billion dollars over he firs en years of he programme. If a premium is required o compensae invesors for he lower liquidiy of indexed bonds (and illiquidiy is no jus a emporary phenomenon due o he low volume of bonds ousanding), 4 5 6 7 Furhermore, inflaion-indexed deb immunizes he governmen budge from inflaion shocks unrelaed o fiscal variables (Barro 2003), whereas nominal deb provides insurance agains governmen consumpion shocks ha lead o higher inflaion (Siu 2004, Lusig, Slee and Yelekin 2008). See eg Bohn (1990), Missale (1997b, 1999), Bacchiocchi and Missale (2005), Giavazzi and Missale (2005), Bernd, Lusig and Yelekin (2010). See eg Shen and Corning (2001), Sack and Elsasser (2004), Sagnes and Coeuré (2005), Campbell, Shiller and Viceira (2009). On he opposie side, Garcia and van Rixel (2007) esimae ha ineres savings in he UK and France on inflaion-indexed bonds were abou 45 basis poins in he period 2004 06. BIS Papers No 65 161
hen expeced cos minimizaion can play a role as relevan as fiscal insurance for he choice of indexaion (see Secion 5.1). I is however clear ha he case for convenional deb canno be made by simply looking a he ex-pos ineres coss of indexaion programmes because ex-pos gains and losses could be emporary and, when aken alone, have lile o say abou insurance effecs (Dudley, Roush and Seinberg 2009). For insance, higher paymens on inflaion-indexed bonds would be perfecly consisen wih fiscal insurance if hey occurred a imes of susained oupu growh. In fac, in he wake of he global financial crisis and he ensuing deflaion, indexed bonds have proved o be a valuable hedge agains oupu conracion (TBAC 2009). Figure 1 shows he gains obained by he US Treasury on he 5-year TIP noe issued in April 2007. No only realized inflaion over he period urned ou o be lower han break-even inflaion, bu price indexaion also provided a useful hedge agains oupu flucuaions, as made clear by he posiive correlaion beween inflaion and real GDP growh. Figure 1 US 5-year TIP mauring Apr 2012 Wheher governmens should issue nominal or inflaion-indexed bonds remains conroversial. While here are no compelling argumens agains indexed bonds, here are no srong argumens for issuing hem eiher. No doub, he adven of independen cenral banks able o conrol inflaion has reduced he imporance of inflaion-indexed bonds as a hedge agains unexpeced inflaion and demand shocks. In paricular, he classical argumen for inflaion-indexed bonds as an insrumen for proecing he real value of he deb agains inflaion shocks unrelaed o oher variables (Barro 2003) has los much of is appeal in sable inflaion environmens where fiscal policy is Ricardian and price sabiliy is ensured by he cenral bank. Then, one may wonder why inflaion-indexed bonds have been issued in counries like France, Greece, Germany and Ialy only afer hey delegaed heir moneary policy o he ECB, and, less recenly, in counries wih inflaion argeing regimes like Canada, he UK and Sweden. Among possible explanaions, wo are worh considering. The firs is ha governmens care abou he risk of inflaion; hey wan o avoid he addiional burden of indexaion a imes of high inflaion and may issue nominal deb o build a consiuency 162 BIS Papers No 65
agains inflaion and preven indexaion from spreading o wages, pensions, ec. (Pecchi and Piga 1999). Then, an independen cenral bank solves hese problems. The second explanaion is ha nominal deb offers an implici insurance agains he realizaion of exremely bad evens: i can be inflaed away in emergencies like wars (Fischer 1983) or is real value may adjus as he price level rises o equilibrae he ineremporal budge consrain (Cochrane 2001 and references herein). When fiscal policy is Ricardian and he cenral bank conrols inflaion his opion is los and so is he benefi of nominal deb. 4. Fiscal insurance: he role of deb mauriy When markes are incomplee and he governmen has only convenional deb a is disposal, i can choose he mauriy of he deb o make is value coningen on he erm srucure of ineres raes. Angeleos (2002) and Buera and Nicolini (2004) show ha, in a real economy wihou capial where governmen consumpion is uncerain, a sufficienly rich mauriy srucure of real bonds can suppor he same disribuion of ax raes as ha obained in a complee marke economy. Alhough, as shown by Faraglia, Marce and Sco (2010), hese resuls canno be generalized o more complex sochasic srucures, hey are neverheless suggesive of he insurance ha convenional deb can provide. The idea is ha he value of a bond (and hus is reurn), being implicily coningen on he realizaion of he ineres rae of he corresponding mauriy, can provide insurance agains budge risk. In paricular, shocks ha adversely affec he budge and raise long-erm ineres raes can be hedged by a fall in he marke value of long mauriy deb. If insead he same shocks led o a fall in long-erm raes, hey could be hedged by a long posiion in long-erm deb funded wih shor-erm deb. To gain furher insigh ino he fiscal insurance role of he mauriy srucure i is useful o look a he governmen s ineremporal budge consrain. Le us resric our aenion o he case where he governmen issues only inflaion-indexed bonds wih differen mauriies; ha is, claims on fuure consumpion. Then, defining wih B 1 j he obligaions (principal redempions and coupons) implied by he bonds ousanding a he end of ime 1 o be paid a mauriy ime j wih j 0,..., M 1, he ineremporal budge consrain (in real erms) can be wrien as: M 1 (1) B q j B j S E m j S 1 1 j j 1 j 1 where E denoes expecaions condiional on informaion a ime, m j j u c u c surplus and j S is he primary is he marginal rae of subsiuion beween consumpion in period and j q j are he prices, a ime, of real zerocoupon bonds mauring in period j ; ie hey are he prices associaed wih he erm srucure of real spo ineres raes.. 8 Finally, Using he Euler equaion q j E m j, from consumer maximizaion, he ineremporal budge consrain can be wrien as: 8 See Angeleos (2002) for a derivaion. To save on noaion he dependence of primary surpluses and consumpion on he hisory of evens is no made explici. BIS Papers No 65 163
M 1 ; (2) B q j B j S q j ES Cov m j S 1 1 j j j 1 j 1 s 1 where Cov denoes he covariance condiional on informaion a ime. Equaion (2) shows ha a long mauriy srucure makes he marke value of he deb sensiive o ineres-rae changes. If negaive shocks o curren and fuure primary surpluses lead o higher ineres raes, he value of long mauriy deb falls and his reduces he need for fiscal adjusmen. 4.1 Governmen consumpion shocks A long mauriy deb srucure provides fiscal insurance agains macroeconomic shocks ha induce a posiive covariance beween ineres raes and governmen financing needs. For insance, governmen consumpion shocks ha lead o an upward shif in he erm srucure of ineres raes can be hedged by a fall in he marke value of long-erm deb (Angeleos 2002, Barro 2003, Buera and Nicolini 2004, Lusig, Slee and Yelekin 2008). This does no mean ha he increase in ineres raes is beneficial. Higher raes do worsen he fiscal posiion, as hey reduce he presen value of fuure surpluses above he direc effec of governmen consumpion, bu a long mauriy srucure minimizes heir impac; he longer he mauriy, he lower he deerioraion in he fiscal posiion and hus he necessary correcion. The governmen s holding of a shor mauriy asse, ie B 1 0, can furher improve he hedging performance of he governmen porfolio, as in he example of Angeleos (2002). Furhermore, insurance is enhanced by long-erm nominal deb o he exen ha fiscal shocks lead o conemporaneous or expeced fuure inflaion (and hus higher long-erm ineres raes) as in Lusig, Slee and Yelekin (2008). How relevan is his argumen for long mauriy deb? Empirical evidence on he impac of governmen spending, and more generally of budge deficis, on ineres raes cass serious doubs on he imporance of his channel. Indeed, he evidence is mixed and, even when he effec of spending on ineres raes appears significan, such effec is esimaed o be small, around a few basis poins (Ardagna, Caselli and Lane 2007, Laubach 2009). As suggesed by heir srong inernaional comovemens, long-erm ineres raes appear o be mainly driven by inernaional risk facors (Codogno, Favero and Missale 2003) and/or global fiscal rends (Dell Erba and Sola 2011). 4.2 Oupu shocks The mauriy srucure can also provide insurance agains shocks ha affec oupu and ax revenues o he exen ha such shocks lead o changes in ineres raes. Finding he mauriy srucure ha provides he bes hedge agains such shocks is however a difficul ask because he covariance beween oupu and ineres raes may vary wih he source of oupu flucuaions. For insance, produciviy shocks are bes hedged by shor mauriy deb because negaive shocks ha reduce oupu and revenues also decrease ineres raes and hus lead o higher reurns on long-erm deb (Faraglia, Marce and Sco 2010). 9 The same is rue for prolonged recessions ha are accompanied by an easing of moneary policy. On he oher hand, supply shocks due o rising wages or energy prices are bes hedged by long mauriy deb especially 9 Pu anoher way, when produciviy and oupu are lower han expeced, a shor mauriy srucure allows policy makers o roll over he deb a low ineres raes hus reducing he need for ax adjusmens. 164 BIS Papers No 65
if he resuling inflaion is counered by higher real ineres raes. In fac, he impac of moneary policy raes on oupu is anoher argumen for a long mauriy srucure. Bacchiocchi and Missale (2005) show ha long mauriy deb is opimal in a model where he cenral bank is able o fully sabilize demand shocks bu has o induce an oupu conracion o couner inflaion from supply shocks. As he covariance beween oupu and ineres raes depends on he source of variaions, on wheher supply or demand shocks prevail, and on he moneary policy reacion o such shocks, lile can be said on wheher a long or a shor mauriy deb srucure should be in place. 4.3 Ineres-rae shocks As he relaion beween ineres raes and fiscal variables is eiher weak or depends on he ypes of shocks hiing he economy, characerizing he opimal mauriy srucure seems a frusraing exercise. However, o he exen ha ineres raes are mainly driven by inernaional facors, say, global fiscal rends and risk appeie or risk awareness (and are hus unrelaed o domesic fiscal variables), long mauriy deb is opimal. A long mauriy srucure immunizes he governmen budge from pure ineres-rae risk, ie from ineres-rae shocks ha are independen of domesic fiscal variables and hus primary surpluses. If we assume ha he covariance erm in equaion (2) is, o a firs approximaion, negligible (and deb obligaions are honoured wih cerainy), hen i is easy o see ha he budge can be insured agains ineres-rae risk, ie agains shocks o he erm srucure q j, by srucuring he deb so ha mauring liabiliies mach curren and fuure primary surpluses (Barro 1995, 2003). If perfec maching were possible, no new deb would be expeced o be issued, and he governmen budge would be immune from ineres-rae shocks. However, since in he real world he mauriy of he deb is ypically shorer han he mauriy of primary surpluses ie B 1 S he governmen budge is exposed o ineres-rae (or refinancing) risk. Any unanicipaed increase in ineres raes would require an increase in axes (or a reducion of governmen spending) o saisfy he ineremporal budge consrain. The necessary revision in ax raes is however lower he longer he mauriy of he deb. This is because he fall in he presen value of fuure surpluses due o an increase in ineres raes is parially hedged by a fall in he marke value of he deb and such insurance effec increases wih deb duraion. Therefore, a long mauriy srucure is needed o hedge agains ineres-rae risk and mainain a sable ax rae. 10 4.4 The risk of defaul A srong case for long mauriy deb also emerges when a Non-Ricardian policy regime is enered ino eiher because fiscal policy becomes unsusainable or is perceived as such due o a sudden shif in marke senimen. The consideraion of deb crises riggered by a revision in economic growh, fiscal fundamenals or a sudden change in invesors confidence suggess ha he risk of defaul should be a main concern of deb managemen. Deb crises also provide a clear insance in which he mauriy srucure of he deb affecs expecaions and ineres raes hus ineracing wih moneary policy, adding o he cases considered in Turner (2011) and Blommesein and Turner (2012). 10 A relaively shorer mauriy srucure would be consisen wih budge insurance only if ineres-rae shocks led o opposie movemens in shor- and long-erm ineres raes producing an inversion of he erm srucure. BIS Papers No 65 165
A long mauriy srucure is he bes insurance agains he risk of defaul because deb crisis episodes are characerized by a fall in expeced primary surpluses and a sharp increase in ineres raes driven by he emergence of sizeable defaul-risk premia. Long-erm deb is hen a naural hedge agains a sudden change in expecaions because is marke value falls when defaul-risk premia rise as a resul of weak fiscal fundamenals or a shif in marke senimen. This is no a new resul; i has long been known ha a long mauriy srucure enhances deb susainabiliy as i minimizes he risk of having o roll over a large share of deb when ineres raes are oo high or marke access is denied (Calvo 1988, Alesina, Prai and Tabellini 1990). However, looking a he ineremporal budge consrain offers new insigh ino he role of deb mauriy. The mauriy srucure ha reduces he risk of defaul can be characerized by looking a he governmen s ineremporal budge consrain (1) modified o consider he possibiliy ha deb obligaions may no be repaid: M 1 * 1 1 j j 1 j 1 B q j B j S E m j S (3) * where a sar on bond prices emphasizes ha q j claims on fuure consumpion, q j are lower han he prices of safe, as he former discoun he possibiliy ha deb commimens will no be honoured in full. Equaion (3) shows ha a downward revision in he expeced pah of fuure surpluses leads * q j, decline due o he o a fall in he marke value of he deb as bond prices, emergence of a defaul-risk componen in ineres raes. Since he uncondiional probabiliy of a defaul occurring a any fuure dae increases wih he horizon considered, he price of bonds falls more he longer heir mauriy, j. As he impac of he probabiliy of defaul on he value of he deb increases wih is duraion, he longer he mauriy of he deb he lower he defaul-risk premium ha is needed o mach he fall in he expeced value of fuure primary surpluses. 11 Therefore, a long (and balanced) mauriy srucure minimizes he risk of defaul ha he marke prices in ineres raes. As deb mauriy is criical for deb susainabiliy, i should be considered as imporan as oher fiscal fundamenals. 4.5 Nominal versus inflaion-indexed deb The policy implicaions of fiscal insurance for he mauriy srucure are usually derived from models where all variables are in real erms and governmen bonds are claims o fuure consumpion, ie hey are indexed o he price level. This raises he issue of wheher, and under wha condiions, hese resuls exend o he case ha he governmen issues fixed-rae nominal bonds. 12 In fac, nominal bonds are sill he predominan financing insrumen despie he rapidly increasing marke in inflaion-indexed bonds and hus he relevan case o consider. Lusig, Slee and Yelekin (2008) show ha when he governmen only issues non-coningen nominal deb, long-erm nominal deb provides insurance agains fiscal shocks ha induce cosly conemporaneous or expeced fuure inflaion and hus higher long-erm ineres raes. 11 12 The discussion is purposely informal. See Cochrane (2001) for a similar role of nominal-deb mauriy in sabilizing expeced inflaion in a model where expeced inflaion plays he same role as he defaul-risk premium in devaluing long mauriy deb following shocks o he presen value of primary surpluses. Cochrane (2001) examines he case of nominal bonds bu assumes consan real ineres raes. 166 BIS Papers No 65
More generally, Bernaschi, Missale and Vergni (2009) find ha a long mauriy srucure of nominal deb is opimal when he nominal erm srucure moves in he same direcion as he erm srucure of real raes, as is he case in a sable inflaion environmen. Consider he ineremporal budge consrain wih nominal deb. While he marke value of nominal deb varies wih nominal ineres raes, he presen discouned value of primary surpluses (being naurally indexed o he price level) 13 depends on he marginal raes of subsiuion beween consumpion a differen daes and hus, o a firs approximaion, on real ineres raes (see equaion (2)). 14 Hence, wheher long-erm nominal deb provides a hedge agains variaions in he presen value of primary surpluses induced by shocks o real ineres raes depends on he relaion beween he erm srucure of real and nominal ineres raes. To he exen ha nominal raes covary posiively wih real ineres raes, ha is, if he nominal erm srucure moves in he same direcion as he erm srucure of real raes, hen previous resuls apply, wih qualificaions, o he mauriy srucure of nominal deb. 15 In paricular, if nominal ineres raes change more han one-o-one wih shocks o real raes, hen he greaer marke-value sensiiviy of nominal deb can provide a subsiue for duraion in hedging agains variaions in he presen value of primary surpluses. However, he opimal duraion of nominal deb should sill be very long, as his effec is unlikely o compensae for he observed much longer duraion of primary surpluses. More realisically, if nominal ineres raes change less han one-o-one wih real ineres raes, hen he argumen for a long mauriy srucure is srenghened because he duraion of he nominal deb mus be longer han ha of primary surpluses o compensae for he lower variaions in nominal ineres raes. The argumen for long nominal deb is also valid for shocks o expeced inflaion o he exen ha such shocks induce a posiive reacion of real ineres raes. This is he case in inflaion argeing regimes where, following he Taylor principle, he cenral bank conrols expeced inflaion by raising he nominal ineres rae more han he increase in expeced inflaion. To conclude, if shocks o nominal ineres raes have a real componen, he argumen in favour of a long mauriy srucure derived for inflaion-indexed deb exends o nominal deb. 5. Deb managemen in pracice How do policy implicaions from fiscal insurance compare wih pracical deb managemen? Mos deb managers focus on aims broadly based around he noion of minimizing cos subjec o an accepable level of risk. In pracice, hey ofen choose deb porfolio sraegies looking a he rade-off beween cos and risk minimizaion of he ineres expendiure obained from sochasic simulaions of macro-dynamic models. The cos-risk managemen of he ineres expendiure apparenly shares wih he fiscal insurance heory he objecive of minimizing budge risk and hus ax adjusmens. However, he managemen of expendiure risk is mainly moivaed by he objecive of minimizing he cos of deb service. Deb managers worry abou expendiure risk because a greaer risk may lead, ex-pos, o higher ineres coss for any given expeced expendiure. This raises he issue of wheher he objecive of cos minimizaion is economically jusified, and especially so 13 14 15 As ax revenues and governmen consumpion increase wih inflaion, primary surpluses are, o a firs approximaion, unaffeced by inflaion. The real value of he deb also depends on he curren price level ha we assume o be sable. See Appendix 1 in Bernaschi, Missale and Vergni (2009) for a formal analysis. BIS Papers No 65 167
since governmens have o pay a risk premium on heir debs o reduce fiscal vulnerabiliy o macroeconomic shocks. 5.1 The cos of fiscal insurance While deb managers aim o minimize he expeced cos of deb service independenly of is source, he fiscal insurance heory holds ha governmens should be ready o pay a premium o avoid risk. To he exen ha risk premia reflec a fair price for insurance, here should be no rade-off beween risk and cos minimizaion: o avoid risk, he governmen should incur higher expeced coss (Bohn 1995, 1999, Nosbusch 2008). Cos consideraions maer only if expeced reurn differenials, ie risk premia, beween alernaive deb insrumens arise because of credibiliy problems, mispricing, marke imperfecions and liquidiy (Bohn 1999, Missale 1997). The reason why he governmen should issue bonds wih higher risk premia o hedge agains macroeconomic shocks is ha i has a comparaive disadvanage in providing insurance o he privae secor, as explained in Bohn (1995). This is because bonds ha have a higher reurn in bad saes of naure (ha is when oupu is lower and he fiscal posiion weaker han expeced) imply higher ax raes on privae-secor income. These ax changes undo he insurance offered by high deb reurns. Hence, a sraegy ha relies on deb insrumens o insure he privae secor is self-defeaing. Opimal axaion models may, however, underesimae he magniude of risk premia for, a leas, hree reasons. Firs, higher risk premia may resul from marke imperfecions, illiquidiy, and perhaps mispricing. In fac, as shown by Mehra and Presco (1985), once we accoun for he low variance of consumpion growh, observed risk premia appear oo high o be generaed by sandard consumpion asse-pricing models such as hose considered in he opimal axaion lieraure. If acual risk premia are oo high because of high risk aversion, hen governmens should refrain from policies which minimize he cos of deb service, as he laer impose significan risks on axpayers. Cos minimizaion is insead warraned if high risk premia reflec privae inermediaion coss due, for example, o illiquidiy. In his case, Bohn (1999) shows ha a governmen s issuance of a safe asse a low cos is welfare improving. The increasing demand for safe and liquid asses in he wake of he global financial crisis suggess ha he argumen has some relevance. The second reason why opimal axaion models may underesimae risk premia is ha bond pricing depends on he equilibrium allocaion of aggregae consumpion because of he assumpions of raional expecaions and a represenaive household. As bond holders differ from axpayers, say, because axes fall on fuure generaions, he welfare maximizing disribuion of axes and aggregae consumpion may no be relevan for deb holders decisions and hus for bond pricing. 16 Perhaps more imporan, by assuming raional expecaions, models of opimal axaion give households he abiliy o correcly perceive he disribuion of ax raes and hus he equilibrium allocaion of consumpion associaed wih alernaive deb-ax schemes. The hird reason is ha he opimal deb srucure is usually derived from non-moneary models or under he assumpion of full commimen. When ime-consisency problems are considered, implicaions for deb managemen change, as firs shown by Lucas and Sokey (1983) in a model of opimal axaion where he governmen issues (explicily coningen) real deb. Credibiliy problems may lead o subsanial expeced reurn differenials among alernaive deb insrumens and imply a rade-off beween fiscal insurance and cos 16 This may however srenghen he argumen for risk minimizaion. 168 BIS Papers No 65
minimizaion (Calvo and Guidoi 1990). If his were he case, he governmen would have o buy less insurance o minimize ineres coss and ax disorions. These consideraions sugges ha our knowledge on he deerminans of he cos of insurance is oo limied o easily dismiss cos minimizaion; cerainly more research effors should be devoed o undersanding he deerminans of risk premia. 17 5.2 The risk-cos managemen of he ineres expendiure A second fundamenal difference beween heory and pracice is ha fiscal insurance focuses on he ineremporal budge consrain; ha is, on he marke value of governmen liabiliies vis-à-vis he presen value of fuure primary surpluses, whereas deb managers are jus concerned wih he sochasic sequence of ineres-expendiure flows or budge deficis. Hence, he fiscal insurance heory implicily assumes an asse-liabiliy managemen framework for he evaluaion of deb financing sraegies whereas he simulaion approach is, a bes, an opimal managemen of expendiure flows. The deb managers focus on ineres expendiure, as opposed o he marke value of he deb, is forced by accouning sandards and by he excessive role ha budge deficis play in fiscal policy evaluaion. How far does his concern ake us away from he policy recommendaions of he fiscal insurance approach? Consider firs he following simple example. Suppose ha he shor-erm ineres rae is expeced o increase so ha he erm srucure is upward sloping consisen wih he expecaions heory. Then, as he long-erm ineres rae is fully deermined by he perfecly foreseen pah of he shor-erm ineres rae, he mauriy of new bond issues is irrelevan for expeced cos minimizaion. Indeed, economic heory holds ha in he absence of a erm premium he ype of deb ha he governmen issues does no maer. However, over a shor ime horizon, he expeced ineres expendiure is minimized by shor mauriy deb. Bernaschi, Missale and Vergni (2009) show ha ineres-expendiure minimizaion may lead o subopimal deb sraegies when carried ou over a shor ime horizon. They evaluae he cos-risk performance of deb porfolios of differen mauriies by examining he ime pah of he sochasic disribuion of heir ineres expendiures. 18 They find ha a very long, possibly infinie, horizon should be aken as he reference period o obain implicaions ha are consisen wih he fiscal insurance heory of deb managemen. 19 Inuiively, porfolio sraegies can be compared in erms of ineres expendiure only if he horizon exends up o he redempion dae of he longes mauriy bond issued during he simulaion period. The analysis poins o he danger of a cos-risk managemen of he ineres expendiure and raises concerns over deb sraegies derived from medium-erm simulaion models such as ha provided by he World Bank and IMF (2009). 20 In he example above, by issuing shorerm deb a governmen would move away from he (long mauriy) porfolio ha minimizes ineres-rae risk and expose he budge o he coss of fuure ineres-rae shocks. The risks of shor-ermism are furher invesigaed in he nex secion. 17 18 19 20 For an analysis of risk premia on inflaion-indexed bonds see Campbell, Shiller and Viceira (2009). The sochasic disribuion of he ineres expendiure over ime is simulaed using simple sochasic models of he evoluion of he erm srucure of ineres raes. We also find ha he ranking of deb porfolios by expendiure risk may depend on he lengh of he simulaion period. Alhough mos governmens run simulaions over a en-year period, hey ofen focus on cos-risk indicaors compued on much shorer horizons (see Risbjerg and Holmlund 2005). BIS Papers No 65 169
5.3 Fiscal rules and he risk of impaience Fiscal rules, such as he Sabiliy and Growh Pac or a Budge Balance rule, make he ineres expendiure he key variable o be conrolled by deb managemen. Then, he excessive role played by curren deficis in he evaluaion of fiscal performance ogeher wih governmens myopic views may disor deb managers choices and favour subopimal deb sraegies. To make a simple example, consider he implicaions of a Budge Balance rule. In order o ensure a balanced budge he nominal primary surplus, S N, has o mach he nominal ineres expendiure, I, ie he sum of coupons, capial uplifs and he per-year difference beween he face values and he issue prices of he ousanding bonds. 21 Defining he ex-pos paymen rae on he ousanding deb as i I B 1, he Budge Balance N rule, S I, can be wrien in erms of he surplus-o-gdp raio, s, and he deb-o-gdp raio, b 1, as: 22 i s b 1 y 1 where y is he growh rae of nominal GDP. If he primary surplus is affeced by oupu shocks so ha is raio o GDP increases wih unanicipaed oupu growh, y E 1y, hen a balanced budge requires ha he governmen offse such shocks by conrolling he policy componen of he primary surplus, for example, he average ax rae. Defining he policy conrolled componen of he surplus as fiscal adjusmen, A, he Budge Balance rule implies: i A b y E y 1 1 1 y where is he elasiciy of he surplus raio o nominal GDP growh; ie we assume, for simpliciy, ha real growh and inflaion elasiciies are he same (which is generally no he case). Equaion (5) shows ha a decline of GDP growh below is naural rae implies an addiional burden o fiscal adjusmen on op of ineres paymens. I also makes clear ha GDP-indexed bonds and, o a lesser exen, inflaion-indexed bonds help o sabilize he policy componen of he surplus by providing an insurance agains shocks o nominal growh. In fac, a sensible objecive funcion for he deb manager would be o minimize he expeced quadraic loss of he fiscal adjusmen in he curren and fuure periods. Assuming wo periods, he presen and he fuure, we have: Min L E A E A (6) 2 2 1 1 1 Subsiuing equaion (5) for A yields: (4) (5) 21 22 According o ESA95 accouning rules, he difference beween he face value and he issue price of a bond divided by is life (from issuance o mauriy) is considered an ineres paymen as well as is coupon. Dividing boh he surplus and he ineres paymens by nominal GDP is jusified by he fac ha he variable ha he governmen conrols is he surplus-o-gdp raio, for example, by choosing he average ax rae. 170 BIS Papers No 65
2 i i i Min L E 1 b 1 Var 1 b 1 2 b 1Cov 1 y ; k 1 y 1 y 1 y 2 i 1 i 1 i 1b E 1 b Var 1 b 2 Cov 1 y 1; 1 y 1 1 y 1 1 y 1 where Var 1 and Cov 1 denoe, respecively, he variance and covariance condiional on he informaion a ime 1 when he deb manager chooses he ype of deb o be issued, and k is an unimporan consan. Equaion (7) shows ha bonds indexed o nominal GDP would provide a valuable hedge agains cyclical variaions in he primary surplus ha are no conrolled by he governmen. Inflaion-indexed bonds could also provide insurance o he exen ha inflaion and real oupu growh were no negaively correlaed, ha is, if supply shocks did no prevail. However, if issuing GDP-indexed bonds is oo cosly because invesors require a premium for illiquidiy and complexiy (see Secion 2.1), hen he choice is beween convenional long mauriy bonds and shor mauriy bonds, say, bonds wih a 10-year and 1-year mauriy. A disincive feaure of boh ypes of bonds is ha heir ineres paymens a period are known a he ime of issuance, 1, which implies ha he condiional variance and covariance erms in he loss funcion for period are zero. However, while he ineres paymens on 10-year bonds will remain fixed for 10 years ahead, 1-year bonds, being rolled over in period, expose he fiscal adjusmen o ineres-paymen uncerainy. Indeed, shor mauriy deb implies greaer ineres-paymen variabiliy a 1 (see he variance erm in he loss for period 1) and may lead o higher fuure paymens when he ineres rae is expeced o rise (see he expeced erm in he loss for period 1). Moreover, shor mauriy deb may lead o addiional losses if ineres raes covary negaively wih nominal GDP growh. Alhough we argued in Secion 4 ha a sysemaic relaion beween ineres raes and oupu growh is hard o find, here may be insances when high raes are associaed wih oupu conracion, say, as in he case of moneary policy ighening o figh inflaion. I is worh saying ha deb managers are aware of he risks and poenially higher fuure coss of shor mauriy deb and op for fairly long mauriies as shown by he acual mauriy srucures of sovereign debs in OECD counries. However, in a ime of crisis, when he governmen srives o achieve budge balance and he defici becomes he focal poin of he economic policy debae, he deb manager s horizon may shoren dramaically. Suppose ha he 1-year yield o mauriy is lower han he 10-year yield eiher because he yield curve is upward sloping or, more generally, because of he presence of a erm premium. Then, an impaien deb manager who discouns he fuure heavily, ie when 0, will only issue 1-year bonds o minimize nex-period ineres paymens (and ease fiscal adjusmen) as his is he only variable ha eners he loss funcion (7) when 0. Therefore, in imes of crisis, when surviving he presen is wha maers mos, focusing on ineres paymens, a concep of dubious economic relevance bu crucial for fiscal rules binding he overall defici, may bias he choice of deb managers in favour of shor mauriy deb. While a forward looking deb manager may ry o resis he urge o cu he ineres expendiure, she may be forced o deliver a nice budge under he pressure of a governmen sriving o mee is commimens. The use of unconvenional swaps conracs by fiscally weak Member Saes o saisfy he 3% defici limi in he run up o EMU is a realworld example of how accouning convenions may se he wrong incenives and disor deb managers choices. No doub, hese examples are exreme bu sill poin o he danger of evaluaing fiscal susainabiliy on he basis of naional accouns figures ha are vaguely relaed o deb susainabiliy, such as he curren defici, he ineres expendiure, and he book value of he deb. Hall and Sargen (2011) show how differen deb reurns are from ineres paymens (7) BIS Papers No 65 171
and hus how differen are he dynamics of he marke value of he deb (relaive o GDP) compared o official figures. In fac, while economic heory and fiscal insurance evaluae deb sraegies for heir impac on he ineremporal budge consrain, and hus look a he marke value of he deb, real reurns, deb mauriy, ec., in mos counries, daa on he marke value of he deb do no even exis! We may feel comforable wih he simple conceps of curren deficis, ineres expendiure, and deb-o-gdp raios, bu we jus abide by convenions: he use of naional accouns as he only sandard o evaluae fiscal policy is a major obsacle o opimal deb managemen. 6. Concluding remarks Deb managemen should aim a minimizing fiscal vulnerabiliy by providing insurance agains macroeconomic shocks affecing he governmen budge. Indeed, a wide consensus has emerged in he lieraure on he benefis of fiscal insurance and deb managers have paid greaer and greaer aenion o reducing he exposure of heir debs o ineres-rae risk and exchange-rae risk. The reliance on domesic currency bonds and he lenghening of he mauriy srucures ha has aken place over he las wo decades is clear evidence of he increased awareness of such risks. However, he fiscal insurance approach does no offer simple policy recommendaions for he specific deb insrumens o be issued. Wheher insurance is beer provided by nominal or inflaion-indexed bonds, by a shor or a long mauriy srucure depends on he ype of shocks hiing he economy. Wha ype of deb should hen be issued? In his paper we have re-examined his issue looking a he fiscal insurance ha inflaion indexaion and deb mauriy can offer in ligh of he differen shocks affecing he governmen budge and heir relevance. Wheher governmens should issue nominal or inflaion-indexed bonds is conroversial. The lack of knowledge abou he ype of shocks hiing he economy suggess porfolio diversificaion as an argumen for some inflaion-indexed deb. On he oher hand, he role of inflaion-indexed bonds as a hedge agains demand shocks or inflaion shocks (unrelaed o oher variables) is less imporan in a sable inflaion environmen when fiscal policy is Ricardian and price sabiliy is ensured by he cenral bank. By conras, here is no doub ha indexaion o nominal GDP would be ideal o hedge agains oupu flucuaions. Issuing GDP-indexed bonds can be cosly because of he premium required for illiquidiy and complexiy bu he ime has come o ake his opporuniy ino greaer consideraion. We have made a srong case for long mauriy deb, eiher nominal or indexed. Our argumen is no based on he relaion beween ineres raes and fiscal variables, which is eiher weak or condiional on paricular shocks, bu on he fac ha a long mauriy srucure avoids ineres-rae risk and, more imporanly, reduces he risk of defaul if expeced fuure primary surpluses fall as a resul of policy or a shif in marke senimen. The euro deb crisis does provide a clear indicaion for he managemen of sovereign deb: a long mauriy srucure is he bes insurance agains he risk of defaul. The mauriy of he deb is a key variable o assess he vulnerabiliy of he governmen fiscal posiion and should hus deserve greaer aenion in deb susainabiliy analysis. An excessive focus on he level of deb, on he debo-gdp raio, as well as on curren deficis, is misleading in he presence of subsanial differences in deb duraion. Moreover, as he original duraion of he deb is modified by swaps conracs, a correc assessmen of fiscal vulnerabiliy calls for a greaer ransparency of such operaions. Finally, we have compared he policy implicaions from fiscal insurance wih he deb managers pracice of minimizing he cos and risk of he ineres expendiure obained from 172 BIS Papers No 65
sochasic simulaions of macro-dynamic models. The managemen of expendiure risk is mainly moivaed by he objecive of minimizing he cos of deb service, aking risk ino accoun. Deb managers worry abou expendiure risk because a greaer risk may lead, ex-pos, o higher ineres coss, for any given expeced expendiure. A concern for he cos of deb service is jusified if expeced reurn differenials beween deb insrumens are deermined by mispricing, marke imperfecions and liquidiy, bu i is no when higher risk premia reflec a fair price for insurance. In he laer case, here is no radeoff beween cos and risk minimizaion. This suggess ha more research effors should be devoed o undersanding he deerminans of risk premia. A second fundamenal difference is ha he fiscal insurance heory focuses on he ineremporal budge consrain, ha is, on he marke value of governmen liabiliies vis-à-vis he presen value of fuure primary surpluses, whereas deb managers are jus concerned wih he sochasic sequence of ineres-expendiure flows. Ineres-expendiure minimizaion may lead o subopimal deb sraegies when carried ou over a shor horizon. To obain implicaions ha are consisen wih he fiscal insurance heory of deb managemen, porfolio sraegies should be compared over a ime horizon ha exends up o he redempion dae of he longes mauriy bond issued during he simulaion period. The deb managers focus on ineres expendiure, as opposed o he marke value of he deb, is forced by accouning sandards and by he excessive role ha budge deficis play in fiscal policy evaluaion. Fiscal rules, such as he Sabiliy and Growh Pac or he Budge Balance rule, make he ineres expendiure he key variable o be conrolled by deb managemen. In imes of crisis, when surviving he presen is wha maers mos, focusing on ineres paymens, a concep of dubious economic relevance bu crucial for fiscal rules binding he overall defici, may bias deb managers choices and favour subopimal deb sraegies. Our analysis poins o he danger of evaluaing deb managemen on he basis of naional accouns figures ha are vaguely relaed o deb susainabiliy, such as he curren defici, he ineres expendiure and he book value of he deb. The lack of a more heorybased accouning framework is a major obsacle o opimal deb managemen. References Alesina, Albero, Prai, Alessandro and Guido Tabellini. 1990. Public Confidence and Deb Managemen: a Model and a Case Sudy of Ialy, in R. Dornbusch and M. Draghi, eds., Public Deb Managemen: Theory and Hisory, 94 124, Cambridge: Cambridge Universiy Press. Angeleos, George-Marios. 2002. Fiscal Policy wih Nonconingen Deb and he Opimal Mauriy Srucure, The Quarerly Journal of Economics, 117(3): 1105 31. Ardagna, Silvia, Caselli, Francesco and Timohy Lane. 2007. Fiscal Discipline and he Cos of Public Deb Service: Some Esimaes for OECD Counries, The B.E. Journal of Macroeconomics, 7(1), Berkeley Elecronic Press. Bacchiocchi, Emanuele and Alessandro Missale. 2005. Managing Deb Sabiliy, CES-Ifo Working Paper 1388, January. Barro, Rober J. 1995. Opimal Deb Managemen, NBER Working Paper Series 5327. Barro, Rober J. 2003. Opimal Managemen of Indexed and Nominal Deb, Annals of Economics and Finance, 4: 1 15. Bernaschi, Massimo, Missale, Alessandro and Davide Vergni. 2009. Should Governmen Minimize Deb Service Cos and Risk? A Closer Look a he Deb Sraegy Simulaion Approach, UNIMI Research Papers in Economics, Business, and Saisics. Economics. Working Paper 38. December. BIS Papers No 65 173
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