Discussion of John Cochrane,

ìU.S. Federal Debt in the 21st Century"

John Y. Campbell

Harvard University

Treasury Roundtable, December 5, 2014

John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 1 / 8
What Is This Paper?

This is a visionary reimagining of the Treasuryís debt management

function.

Cochrane challenges not one but Öve shibboleths:

I The Treasury issues debt, the Fed creates money

I The Treasury relies on primary dealers to operate primary and

secondary markets for Federal debt

I The Treasury ensures predictable debt supply in the short run and does

not respond to prices

I The Treasury always makes its promised coupon and principal payments

I The Treasury issues Federally taxable debt.

John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 2 / 8
What Is This Paper?

Cochraneís proposals:

I Replace Treasury bills with divisible, electronically transferable,

áoating-rate, Öxed-value instruments (electronic money, comparable to

reserves at the Fed)

I Disintermediate primary dealers by issuing permanent long-term debt

instruments that can be traded on exchanges

I Fix prices at the short end, giving up quantity control, and use swaps

to manage Treasury interest-rate risk exposure

I Allow the Treasury discretion over coupons, relying on reputation to

limit abuse of this discretion

I Issue both taxable and nontaxable debt, competing with municipal

issuers.

John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 3 / 8
Who Is the Author?

Moses? Or Samson? John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 4 / 8
Treasury Electronic Money

Technology is opening up new possibilities.

Provision of money is a core function of government, but government

may have to innovate to compete with high-tech private-sector

alternatives (Bitcoin).

If one could replace currency altogether, an even greater prize would

be attainable

I Elimination of the zero lower bound on the nominal interest rate

I This would drastically simplify the operation of monetary policy in a

low-ináation environment.

John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 5 / 8
Perpetuities

Cochrane wants to create a perpetuity such that new issues are

indistinguishable from old ones.

I I am sympathetic to this suggestion as a way to enhance liquidity.

Britainís consols actually do not satisfy this condition, because they

are redeemable at par so the coupon rate matters.

A potential problem: perpetuity has modiÖed duration D

 = 1/Y ,

which can be very high when yields are low.

A potential solution: a perpetuity with coupons that grow

geometrically at rate G < 0, and modiÖed duration D

 = 1/(Y  G).

John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 6 / 8
Discretionary Coupons

Cochrane wants to give Treasury discretion over coupons, ìwithout

triggering default.î

Problematic because

I If bondholders expect Treasury to use this discretion, yields increase

and borrowing becomes more expensive unless Treasury actually does

cut coupons

I If bondholders do not expect Treasury to use this discretion, any cut in

coupons is a surprise and has the same reputational e§ects as default,

regardless of the legal deÖnition.

In the current regime, the US beneÖts from its ability to borrow

cheaply in bad states of the world.

I This o§sets the increase in the market value of long-term outstanding

debt which occurs when long yields fall in bad states.

I fear that this proposal pulls down the pillars of the temple rather

than building better infrastructure.

John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 7 / 8
Taxable and Nontaxable Debt

Cochrane makes two arguments for Treasury nontaxable debt:

I An e¢ cient way to transform future tax revenues into current resources

I Taxable TIPS are not safe long-term assets for taxable investors given

the taxation of nominal interest.

The Örst argument is not compelling:

I One can always adjust the quantity of bonds sold to achieve the same

intertemporal resource transfer with either type of debt

I Progressive taxes create multiple classes of taxable investors, and

nontaxable debt may beneÖt investors in the highest tax bracket if the

marginal investor is in a lower tax bracket.

The second argument is legitimate, but there are alternative Öxes:

I Tax-favored retirement accounts

I Keep ináation under control

I Tax reform to tax real not nominal interest income.

John Y. Campbell (Harvard University) Discussion of Cochrane Treasury 2014 8 / 8