A Comparative-Advantage Approach to Government Debt Maturity
Executive Summary — Can the government do anything to discourage short-term borrowing by the private sector? HBS Professor Robin Greenwood, Harvard University and Harvard Business School PhD candidate Samuel Hanson, and Harvard University Professor Jeremy C. Stein suggest the government could actively influence the corporate sector's borrowing decisions by shifting its own financing between T-bills and bonds. Key concepts include:
- Historically, there is a strong correlation between the maturity of government debt and the ratio of debt-to-GDP.
- There is effectively a regulatory dimension to the government's debt-maturity choice.
- The title of the paper refers to the idea that, in choosing the optimal maturity structure of its debt, the government balances the costs of rollover risk with the system-wide benefits of crowding out private sector money creation. In other words, the government should keep issuing short-term bills as long as it has a comparative advantage over the private sector in the production of riskless money-like securities.
- Treasury could both create valuable incremental monetary services, as well as have a potentially powerful crowding-out effect on the private sector, by issuing more in the way of, say, two and four-week bills. A simple calculation shows that this may be done without much of an increase in rollover risk.
We study optimal government debt maturity in a model where investors derive monetary services from holding riskless short-term securities. In a simple setting where the government is the only issuer of such riskless paper, it trades off the monetary premium associated with short-term debt against the refinancing risk implied by the need to roll over its debt more often. We then extend the model to allow private financial intermediaries to compete with the government in the provision of money-like claims. We argue that if there are negative externalities associated with private money creation, the government should tilt its issuance more towards short maturities. The idea is that the government may have a comparative advantage relative to the private sector in bearing refinancing risk and hence should aim to partially crowd out the private sector's use of short-term debt.