U. S. Federal Debt in the 21st Century

John H. Cochrane

University of Chicago, Hoover Institution, NBER

December 2014
Outline

Structure of U.S. Debt?

1. Fixed-value áoating rate.

2. Nominal perpetuities

3. Indexed perpetuities

4. Taxable + tax free

5. Variable coupon

6. Swaps

7. Fed/Treasury accord on maturity, real/nominal, etc.

Goals

1. Funding debt at least cost. Easy to borrow when needed.

2. Providing liquid and useful securities, where the Government has a

natural advantage. Both policy and #1.

3. Managing interest rate and other risks to the U. S. budget.

4. Tools for optimal Öscal (-monetary?) policy.

Goals today

1. Why not? Unforeseen problems? Objections? Additions?
Short debt

Features

I Fixed-value ($1.00), áoating-rate, electronically transferable,

arbitrary denominations, perpetual. Sexy name?

I Fixed value: Buy/sell freely ($1 reserves = 1 bond). Accept for

taxes.

I Rate = interest on reserves. (Depends on Fed policy. Auctions,

index, if not?)

Why

I No rollover, no rollover costs. (Sorry, dealers.)

I Basis for better retail electronic transactions.

I Best Ölls ìliquidity (collateral?) demandî for government debt.

I Run free interest-paying electronic money = 21st century currency.

I ìOptimal quantity of money.î Reserves for all!

Objections

I Q: Demand? A: Fed innovations popular, and useful if small.

I Q: Quantity not perfectly controlled. A: A problem?

I Q: Price level control? A: MV=PY a lost cause. Fed retains

(strengthens) i control.

I ?
Long debt

Perpetuities

I $1 coupon forever. Repay by repurchasing.

I Pay with Öxed value debt?

I Let current debt roll o§.

Why

I Liquidity. One security! No on/o§ run spread.

I Much historical precedent.

Objections

I Q: Desire for coupon debt? A: Why? Easy for banks/funds to

synthesize coupons or zeros for retail customers.

I ?
Tax status

Tax-free debt

I Issue both taxable and tax free áavors.

I Free of all Federal tax including personal and corporate income tax

and estate taxes. Press states/local to exempt as well.

Why

I The point of debt is to get money now at expense of future taxes.

Tax free debt has a higher yield, collect the future taxes now.

I Investors may prefer to overpay now and avoid complex legal and tax

avoidance costs later.

I Removes intertemporal distortions, can supplant much complex

tax-sheltered investing.

Objections

I Q: ìLose tax revenue.î A: No. Collect it sooner.

I ?
Ináation

Indexed debt

I Perpetual. Coupon pays $1 timesCPI.

I Example: CPI today = 230. Coupon pays $2.30.

Why / alternatives

I One security, independent of issue date. Should increase liquidity.

I Symmetric treatment of ináation / deáation.

I (Tax free) Indexed perpetuity = ideal risk free asset. ! Large

demand, low yield.

I For other countries: Domestic vs. foreign currency debt. U.S?

Objections

I ?
Government equity

Variable coupon debt

I Perpetuities with the right to raise or lower coupon payments

without legal default.

I Politics: Treasury? Act of Congress?

Why

I Seamlessly reduce payments in times of Öscal stress.

Alternatives

I Rules vs. reputations. Trills. Corporate dividends. Voters =

shareholders?

I Analogy: Suspensions of Convertibility.

I All debt (better ex post, fewer kinds of debt)? Or part only (cheaper

yields ex ante)?

Objections

I ?
Risk management

Swaps

I Fixed-áoating; Indexed-nominal.

I Others? Taxable-nontaxable? All?

Why

I Separate liquidity provision, meeting market demands for speciÖc

bonds, from risk exposure.

I Example: Market wants lots of áoating rate ìmoney-likeî debt. But

if interest rates rise, interest costs rise. Solution: issue lots of

áoating-rate, swap to Öxed.

I Implicit: demand for characteristics beyond maturity. Demand for

bonds 6= demand for swaps.

I Allows quicker adjustments of maturity/index/tax structure than

buying and selling bonds.

I Tradeable treasury swaps should be liquid and popular in the

secondary market.

Objections

I Q: Swap counterparty risk? A: Collateralized, and what is all this

regulation for anyway?

I ?
Accord

Needed: New Fed-Treasury Accord

I No more we sell, you buy.

I Who is in charge of the maturity/index/tax structure of debt?

(Treasury?)

I Who is in charge of short term interest rates? (Fed, via IOR?)

How do we use these tools?

I Optimal (state-contingent) maturity structure (bonds+swaps)?

Index vs. nonindex? Or target spread? Taxable vs tax free? (Or

target spread) How much variable coupon debt? When to

raise/lower the coupons?

I Long but unconcluded optimal-taxation, optimal-debt literature (e.g.

Lucas-Stokey.)

I Once you know the answers, most have macro (Fed) and budgetary

(Congress) as well as debt-cost (Treasury) implications.

Accord/coordination is not simple.