R OBIN G REENWOOD, S AMUEL G. H ANSON, J OSHUA S. R UDOLPH, & L AWRENCE H. S UMMERS G OVERNMENT D EBT M ANAGEMENT AT THE Z ERO L OWER B OUND 2014 R OUNDTABLE ON T REASURY M ARKETS A ND D EBT M ANAGEMENT

I.Quantify Fed vs. Treasury conflict in QE era II.Fed vs. Treasury in historical perspective III.A modern framework for debt management IV.Ways to resolve Fed vs. Treasury conflict O UR P APER

QE3QE1QE2Twist 15.6 % 10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) The Fed’s Quantitative Easing (QE) policies have reduced the net supply of long-term securities. P ULLING IN O PPOSITE D IRECTIONS

QE3QE1QE2Twist 5.6% 10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) Meanwhile the Treasury was doing the opposite, extending the average maturity of its borrowings. P ULLING IN O PPOSITE D IRECTIONS

QE3QE1QE2Twist Net Impact: 10.1% 10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) P ULLING IN O PPOSITE D IRECTIONS

10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) P ULLING IN O PPOSITE D IRECTIONS

Before 2008, the Fed’s balance sheet was far smaller. As a result, the Fed had little impact on the maturity structure of the government’s consolidated debts. F ED VS. T REASURY H ISTORICALLY

Shorter-termLonger-term Low cost financingLimit fiscal risk T RADITIONAL D EBT M ANAGEMENT Treasury’s traditional approach to determining the appropriate maturity of the debt traded off a desire to achieve low cost financing against the desire to limit fiscal risk.

T RADITIONAL D EBT M ANAGEMENT Issuing short-term is “cheaper” because it allows Treasury to capture the “liquidity premium” on T-bills and to conserve on the “term premium” investors demand to hold long bonds. Liquidity premium on short-term T-bills, Basis points

T RADITIONAL D EBT M ANAGEMENT Term Premium on 10-Year Zero-Coupon Treasuries (1990 to 2014)

T RADITIONAL D EBT M ANAGEMENT What is fiscal risk? Refinancing risk If the government issues short-term, it is exposed to increases in interest rates If the government issues long-term, it ‘locks in’ the cost of capital Rollover risk Failed auction Self-fulfilling bank run

Shorter-termLonger-term Low cost financing Limit fiscal risk T RADITIONAL D EBT M ANAGEMENT The desire to limit fiscal risk looms larger when the overall debt burden rises.

T RADITIONAL D EBT M ANAGEMENT Thus, Treasury has historically tended to extend the average maturity of the debt when debt-to-GDP rises. Much like the Treasury is doing today.

Actual Path of Deficits Deficits in Counterfactual Case in which Treasury rolled over 3-mo Bills Q UANTIFYING F ISCAL RISK : A C OUNTERFACTUAL We argue that the “fiscal risk” generated by issuing short-term debt is less important than traditionally thought.

Shorter-termLonger-term Low cost financingLimit fiscal risk T RADITIONAL D EBT M ANAGEMENT

Shorter-termLonger-term Low cost Limit fiscal risk M ODERN D EBT M ANAGEMENT Modern debt management recognizes that the maturity of government debt may also be a valuable tool for managing aggregate demand and promoting financial stability. Aggregate demand Financial stability

Shorter-termLonger-term Low cost Limit fiscal risk D EBT M ANAGEMENT C ONFLICTS Aggregate demand Financial stability Fed Treasury Objectives of modern debt management have been delegated to Treasury and Fed, which assign different policy weights to potentially conflicting goals

Outside of the zero-lower-bound, Fed sterilization of Treasury debt management is imperfect workaround Fed gets last word using short rate But sterilization no longer possible at the ZLB Expansionary monetary policy at ZLB Extend average duration to mitigate fiscal risk (Treasury) Shorten average duration to bolster aggregate demand (Fed) Fed and Treasury in direct conflict over objectives If all weight on Fed’s objective function, then Fed can presumably do more QE Realistically, dollar amount of QE limited by political considerations D EBT M ANAGEMENT C ONFLICTS

Treasury and Fed release annual joint statement on combined public debt management strategy Forces each agency to internalize other’s objectives Fed charged with routine tactical adjustments because of its expertise in open-market operations Our proposal is NOT in conflict in any way with Fed independence, if anything it seeks to bolster it Our proposal similar in nature to the cooperation between UK DMO and BOE starting in 2009 Mervyn King “If the facility were to be used to purchase gilts, it would be important that the Government’s debt management policy remain consistent with the aims of monetary policy….I should be grateful if you could confirm that this will be the case.” B ETTER SOLUTION