Robin Greenwood, Samuel G. Hanson, 

Joshua S. Rudolph, & Lawrence H. Summers

Government Debt Management at the Zero Lower Bound 

2014 Roundtable on Treasury Markets

And Debt Management

Quantify Fed vs. Treasury conflict in QE era

Fed vs. Treasury in historical perspective

A modern framework for debt management

Ways to resolve Fed vs. Treasury conflict

Our Paper

QE3

QE1

QE2

Twist

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.

Pulling in Opposite Directions

QE3

QE1

QE2

Twist

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.

Pulling in Opposite Directions

QE3

QE1

QE2

Twist

Net Impact: 

10.1%

10-year duration equivalents, Change since Dec. 31, 2007

(% of GDP)

Pulling in Opposite Directions

10-year duration equivalents, Change since Dec. 31, 2007

(% of GDP)

Pulling in Opposite Directions

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.

Fed vs. Treasury Historically

Shorter-term

Longer-term

  Low cost financing

Limit fiscal risk

Traditional Debt Management

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.

Traditional Debt Management

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

Traditional Debt Management

Term Premium on 10-Year Zero-Coupon Treasuries (1990 to 2014)

Traditional Debt Management

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-term

Longer-term

 Low cost financing

 Limit fiscal risk

Traditional Debt Management

The desire to limit fiscal risk looms larger when the overall debt  burden rises. 

Traditional Debt Management

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

Quantifying Fiscal risk: A Counterfactual

We argue that the “fiscal risk” generated by issuing short-term debt is less important than traditionally thought.

Shorter-term

Longer-term

  Low cost financing

Limit fiscal risk

Traditional Debt Management

Shorter-term

Longer-term

 Low cost

Limit fiscal risk

Modern Debt Management

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-term

Longer-term

 Low cost

Limit fiscal risk

Debt Management Conflicts

 Aggregate demand

Financial stability

Fed

Fed

Treasury

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

Debt Management Conflicts

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.”

Better solution

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