DAVID WESSEL EDITOR THE $13 TRILLION QUESTION HOW AMERICA MANAGES ITS DEBT The $13 Trillion Question The $13 Trillion Question How America Manages Its Debt David Wessel EDITOR BROOKINGS INSTITUTION PRESS Washington, D.C Copyright © 2016 THE BROOKINGS INSTITUTION 1775 Massachusetts Avenue, N.W., Washington, D.C 20036 www.brookings.edu All rights reserved No part of this publication may be reproduced or transmitted in any form or by any means without permission in writing from the Brookings Institution Press The Brookings Institution is a private nonprofit organization devoted to research, education, and publication on important issues of domestic and foreign policy Its principal purpose is to bring the highest quality independent research and analysis to bear on current and emerging policy problems Interpretations or conclusions in Brookings publications should be understood to be solely those of the authors Library of Congress Cataloging-in-Publication data Names: Wessel, David, editor Title: The $13 trillion question : how America manages its debt / David Wessel, editor Other titles: Thirteen trillion dollar question Description: Washington, D.C : Brookings Institution Press, [2016] | Includes bibliographical references and index Identifiers: LCCN 2015034769 | ISBN 9780815727057 (pbk : alk paper) | ISBN 9780815727064 (epub) | ISBN 9780815727071 (pdf) Subjects: LCSH: Debts, Public—United States | Finance, Public— United States | Fiscal policy—United States | Monetary policy—United States Classification: LCC HJ8101 A4155 2016 | DDC 336.3/40973—dc23 LC record available at http://lccn.loc.gov/2015034769 Typeset in Minion Pro Composition by Westchester Publishing Services CONTENTS Acknowledgments Preface Robin Greenwood, Samuel G Hanson, and David Wessel The Optimal Maturity of Government Debt Robin Greenwood, Samuel G Hanson, Joshua S Rudolph, and Lawrence H Summers COMMENT by Janice Eberly COMMENT by Brian Sack 28 33 43 COMMENT by Mary John Miller 76 79 81 83 COMMENT by Stephen G Cecchetti COMMENT by Jason Cummins Debt Management Conflicts between the U.S Treasury and the Federal Reserve Robin Greenwood, Samuel G Hanson, Joshua S Rudolph, and Lawrence H Summers COMMENT by Paul McCulley vii ix A New Structure for U.S Federal Debt John H Cochrane 91 COMMENT by Darrell Duffie 139 Concluding Observations Lawrence H Summers 147 Contributors Index 155 157 About the Hutchins Center on Fiscal and Monetary Policy The Hutchins Center on Fiscal and Monetary Policy provides independent, nonpartisan analysis of fiscal and monetary policy issues in order to improve the quality and effectiveness of those policies and public understanding of them It draws on the expertise of Brookings Institution scholars and of experts in government, academia, think tanks, and business, as well as the guidance of its Advisory Council. By commissioning research, convening private and public events, and harnessing the power of the Internet, it seeks to generate new thinking, promote constructive criticism, and provide a forum for reasoned debate The Center was founded with a gift from the Hutchins Family Foundation AC KNOW LEDG MENTS In addition to the fine authors and commenters included in the chapters that follow, we are grateful to the many others who contributed to this book Several of the chapters were first presented as working papers at a Hutchins Center on Fiscal and Monetary Policy event at the Brookings Institution in September 2014 The conference versions of those papers were improved upon by contributions from copyeditor Martha Schultz and Hutchins Center staff Emily Parker and Parinitha Sastry Special thanks to research assistant Brendan Mochoruk, who pulled together many parts from many contributors and helped turn the papers into a cohesive book At the Brookings Institution Press, director Valentina Kalk, editorial director Bill Finan, and managing editor Janet Walker ushered the book through publication, with the help of John Donohue, project editor at Westchester Publishing Services vii PREFACE Robin Greenwood, Samuel G Hanson, and David Wessel T here is a lot of attention on the size and growth of the federal debt, and for good reason The U.S Treasury is the world’s biggest borrower As of fall 2015, it had run up a debt of more than $13 trillion, not counting the money the government owes to Social Security and other government trust funds In the fiscal year that ended September 30, 2015, the federal debt increased by $725 billion, a sum larger than the economic output of all but the world’s twenty largest economies.1 Measured as a share of the nation’s economic output, the federal debt today is larger than at any time since the end of World War II Despite the growing concern about the fiscal health of the U.S government, Treasury bills, notes, and bonds are still the world’s most widely held and trusted debt securities There is much less attention paid to how the Treasury borrows all this money—how much is borrowed short-term and how much long-term, how much is borrowed at fi xed interest rates and how much at rates that vary with inflation, and so on These debt management decisions are the subject of intense scrutiny by bond traders, sophisticated institutional investors, Table S-13, “Federal Government Financing and Debt,” Fiscal Year 2016 Budget of the U.S Government (www.whitehouse.gov/sites/default/fi les/omb/budget/fy 2016/assets/tables.pdf ) ix Concluding Observations 149 context of broad macroeconomic policy—certainly in an economy where the zero lower bound is an issue and probably much more generally How to Think about Treasury Borrowing Costs For reasons explained more fully in chapters 1 and 2, I believe that considerable confusion attends most discussions of the maturity structure of Treasury debt, even taking as given their narrow perspective It is often baldly stated that the objective of the Treasury is, or ought to be, minimizing expected cost over time I would have thought that the objective of the Treasury was to minimize risk-adjusted costs There are any number of actions that participants in well-functioning capital markets can take that have a positive expected return that are nonetheless not thought right to take For example, an individual, or a firm, or the Treasury can make an expected value profit by selling put options, but this simply is taking on risk and being appropriately compensated If the Treasury takes on risk on behalf of taxpayers and is compensated less than fairly, it is making a mistake, even if its expected borrowing cost is reduced It should instead minimize risk-adjusted costs This point may be of some significance In many periods, bond and stock returns are correlated one way or the other If the Treasury issues longer-term bonds and bears or receives some risk premium that reflects the “beta” of the bonds, this may be wise Another point is this: I am convinced that rollover risk treated as an independent issue is mostly a confusion I recognize that circumstances could arise in which the Treasury would not be able to sell debt, or would be able to sell it only at prohibitive rates For all relevant purposes, one can think of such times as moments when the interest rate becomes very high or infinite A proper analysis of cost minimization will recognize that it is very costly to issue debt when rates are very high And any cost minimization strategy will, if possible, take to zero the probability of having to raise debt when doing so is impossible In that regard the frequently expressed conviction that floating-rate debt provides insulation against rollover risk also seems to me a confusion Imagine that the Treasury suddenly converted half of its short-term debt to floating-rate debt People who buy the short-term debt at every auction would buy the floating-rate debt instead At the difficult moment when you had to issue half as much debt as you did before because you have floating-rate debt, you 150 L H Summers would also have only half as many participants showing up at the auction because they already had the floating-rate debt So the prospect that you would avoid an interest rate spike is, I believe, a nearly complete confusion There may be transaction cost reasons—indeed, there probably are—for issuing floating-rate debt, but the idea that floating-rate debt mitigates rollover risk is an error The academic literature has devoted enormous attention to considerations around tax smoothing in formulating debt management policies and indeed in thinking more generally about fiscal policy I find this odd given that the welfare consequences of variations in tax rates are very small James Tobin famously made the observation that it takes a heap of Harberger triangles to fill an Okun gap as a way of making the point that microeconomic distortions from taxation are small compared to macroeconomic losses from recessions The welfare losses from variation in tax rates are trivial even compared to the welfare loss from the average level of taxation Here is a calculation that illustrates the point Assume that taxes in the United States represent about 30 percent of GDP, including those at the state and local level Assume that the deadweight loss from taxation is 15 percent of GDP, which is a fairly high-end estimate, and further assume that the deadweight loss from taxation rises as the square of the tax rate, as is standard It follows that each incremental dollar of revenue raised generates an equal amount of deadweight loss, so this is taking a very serious view of tax distortions Then it turns out that the extra loss from varying tax rates between, say, 27 and 33 percent is just 0.3 percent of GDP Variation of this magnitude is far more than what we observe outside of major wars, and even further beyond what could conceivably come from variations in debt management policies I conclude that debt managers can, and those who purport to advise them should, outside of war time ignore tax-smoothing issues in thinking about cost minimization And there is one last logical point to make regarding tax smoothing The presumption that tax smoothing is better accomplished with the issuance of long-term debt is unwarranted What matters is the real interest rate, not the nominal interest rate It is not obvious that the real ex-post interest rate on Treasury debt will be more stable or predictable with long-term nominal debt and variable inflation than with floating short-term debt The simulations in chapter 1 of this book suggest that the extra uncertainty introduced by moving toward short-term debt is likely to be very, very small It is my observation that there is a very substantial quantity of private Concluding Observations 151 sector activity that is directed to the bond carry trade, that is directed to surfing the yield curve and collecting the resulting term premium, and that is carried out on a substantial scale by thoughtful market professionals who believe that they are being compensated in a way that goes beyond any correlation with the stock market or anything else For as long as that is the case, I would establish a strong presumption that Treasury debt management should be shorter than it is It is certainly possible that if the Treasury issued all short-term debt, the risk would turn negative and at that point, it would be appropriate for the Treasury to be shifting toward more long-term debt But the basic criteria is, if a trade is really good for hedge funds to make, then it is a bad trade for the Treasury to make on behalf of taxpayers I believe there is a substantial amount of sophisticated financial activity that in one way or another takes the form of issuing short and lending long If that is, in fact, the case, it is appropriate for the Treasury, on behalf of taxpayers, to move in the same direction How far the Treasury could move and have that remain the case is an empirical question I believe and suspect that the answer is a fair distance Reflections on Quantitative Easing Quantitative easing, which is a kind of debt management policy, has complex effects on economic performance I am very much aware that there were moments when Ben Bernanke expressed an opinion about QE or a judgment about the future of QE and the next ten minutes were among the most exciting ten minutes in the lives of market participants So I not suppose that Robert Barro’s neutrality theorem and the like are entirely empirically accurate descriptions of what takes place.1 Nonetheless, I would highlight an aspect of the discussion of QE that I find surprising The price-pressure channel—the notion that Fed purchases of bonds push up their price and, thus, push down their yield—either is important or it is not I understand how somebody could believe that QE, because it represented a major public effort to purchase long-term bonds, had a substantial effect on reducing long-term bond yields I understand how the same person could believe that a substantial increase in deficits in the present or in the future could be expected to raise long-term yields substantially because the market would have to absorb much more long-term debt I See chapter 1 for a discussion of this theorem 152 L H Summers not, on the other hand, understand the widespread view on the part of my friends that large deficits and their potential impact on long-term yields are a matter of no concern but that QE, through its price-pressure channel, is a vitally important step toward stimulus Moreover, as my coauthors and I emphasize in chapter 1, relative to what anybody would have expected, the private markets had to absorb far more long-term Treasury debt than anyone would have found plausible in 2007 Despite the expansion of the Fed’s balance sheet, the net effect of what the public sector has done has been to force much more market holding of longterm government debt Therefore analyses of what’s happening in bond markets and stock markets that are premised on the argument that the Fed has expanded its balance sheet by buying a lot of long-term debt miss the highly pertinent empirical observation that the Treasury has done more bondselling than the Fed has done bond-buying, and the Treasury has almost certainly done more unexpected selling than the Fed has done unexpected buying over the last few years Governing Debt Management Policy I am more confident in the basic notion that there should be some approach the coordination of Trea sury and Federal Reserve policy in terms of debt maturity than I was when my colleagues and I were first critical of current arrangements John Cochrane and others have impressed on me that the notion of the separation of fiscal and monetary policy is itself a bit of an intellectual confusion Everybody seems to agree that monetary policy affects various interest rates Everybody agrees that interest rates affect the government budget constraint, therefore there is no such thing as a monetary policy decision that does not have fiscal policy consequences or, alternatively, if you regard the fiscal policy as initially determinative, there is no such thing as a fiscal policy that does not have monetary policy consequences The corollary is that there is never going to be a complete independence of monetary and fiscal policy The argument for coordination is not, as some caricature it, an assertion that the Treasury should interfere with the Fed’s independence Rather, it is that the Fed should have some influence on what the Treasury does in the debt management area, especially when interest rates are constrained by the zero lower bound Concluding Observations 153 When at the zero lower interest bound, the Federal Reserve commits itself to pursuing a QE-type policy, what is the consequence of the Treasury deciding at that point to move to term out the debt? It depends on how the Fed responds One possibility is that the Fed responds passively and doesn’t change its QE policy If that’s how the Fed responds, then the consequence is contractionary for aggregate economic activity It is hard to understand why at moments when the Fed is using QE as an expansionary instrument the Treasury would wish to offset its effects Certainly no such rationale was ever expressed during the recent episode The alternative possibility is that the Fed is in some sense the last mover and follows the Treasury, and the Fed sets the scale of its QE policy to achieve the desired degree of stimulus and thereby offsets any contractionary Treasury policy If this is what happens, the Treasury’s decisions have no impact on either the path of stimulus or the federal budget (given that all Fed profits are rebated to the Treasury) Nonetheless, offsetting Treasury and Fed actions seems inferior to the Fed acting without Treasury offset With coordination, transaction costs are reduced because there is no need for the private sector to intermediate between the Treasury and the Fed And the size of the Fed balance sheet and the attendant anxiety it creates is reduced Some suggest that any coordination of debt management policy threatens the independence of the Fed This might be a worry if the Treasury was pressing the Fed for more expansion, as it would raise the concern of the politicization of monetary policy for short-run benefit that leads to support for the independence of central banks But, in the context here, the issue has been the Treasury offsetting the potential stimulative impact of Fed policies I can see no legitimate reason why the Fed should not have a voice in encouraging the Treasury to stop doing this What Should Be Done? Finally, if I were not currently an academic trying to provoke and I were Secretary of the Treasury, what would I about debt management? It would of course depend on the political context, the views of others, and the economic situation But, I would try to take a number of steps First, I would seek to ensure that debt management decisions were made on the basis of overall considerations of economic welfare, not only the functioning of debt markets Toward this end, I would restructure the Treasury 154 L H Summers Borrowing Advisory Committee to give voice to nonfi nancial institution stakeholders in debt management decisions These would include macroeconomists who could advise on the impact of debt management decisions on economic activity and regulators who could address the impact of debt management policy on financial stability Second, I would instruct debt management officials to review current approaches to determining the maturity distribution of the debt, with a view to reducing profit opportunities for private market participants at the expense of the Treasury In general I would seek to guide policy toward issuing more debt at maturities where term premiums were low and less at maturities where term premiums were high At most moments, but possibly not the present, this would likely means shortening the maturity of the debt Third, I would seek to reach a new Treasury–Federal Reserve accord on debt management policy appropriate to current conditions In particular, the fact that the Fed is likely to have a large balance sheet for the foreseeable future and intends to pay interest on reserves, turning them into the equivalent of Treasury bills, represents a profound change in the monetary policy environment Given that the Treasury and Federal Reserve are part of the same government, it makes no sense for them to independently and separately make decisions about the maturity structure of the outstanding debt I would propose that except when interest rates were close to zero, the Fed would not engage in policies directed at changing the maturity structure of the debt held by the public Decisions about debt maturity structure would then fall to the Treasury On the other hand, when rates were close to zero and so variations in short-term rates were not available as a stabilization tool, I would commit that the Treasury would not act in ways that offset Fed policies unless encouraged to so by the Fed Of course, a great deal of effort would have to go into formulating these principles precisely, and there would be operational details to work out But I would push very hard for some set of principles that ensured that one country had one debt management policy CONTRIBUTORS STEPHEN G CECCHETTI Professor of International Economics, Brandeis International Business School; member of Advisory Council, Hutchins Center for Fiscal and Monetary Policy, Brookings Institution JOHN H COCHRANE Senior Fellow, Hoover Institution, Stanford University JASON CUMMINS Chief U.S Economist and Head of Research, Brevan Howard Inc DARRELL DUFFIE Dean Witter Distinguished Professor of Finance at the Graduate School of Business, and Professor (by courtesy), Department of Economics, Stanford University JANICE EBERLY James R and Helen D Russell Distinguished Professor of Finance, Kellogg School of Management, Northwestern University ROBIN GREENWOOD George Gund Professor of Finance and Banking, Harvard Business School 155 156 Contributors SAMUEL G HANSON Assistant Professor, Finance Unit, Harvard Business School PAUL MCCULLEY Chairman, Global Society of Fellows, Global Interdependence Center; former Managing Director and Chief Economist, PIMCO MARY JOHN MILLER Former Under Secretary of the Treasury for Domestic Finance, U.S Department of the Treasury; former Director of the Fixed Income Division, T Rowe Price JOSHUA S RUDOLPH Master in Public Policy, Harvard Kennedy School of Government BRIAN SACK Director of Global Economics, The D E Shaw Group; former Executive Vice President, Federal Reserve Bank of New York LAWRENCE H SUMMERS Charles W Eliot University Professor, Harvard University DAVID WESSEL Director, Hutchins Center on Fiscal and Monetary Policy, Brookings Institution INDEX Adrian, Tobias, 35 Agency securities, 45 Aggregate demand: debt management objectives for, 15–16, 27, 29, 34, 36, 45, 68; and liquidity premia, 70, 75; quantitative easing to manage, Aguiar, Mark, 132 Amador, Manuel, 132 Annuities, 111 Arbitrage spreads, 107 See also Bid-ask spreads Argentina: GDP-linked debt in, 130; inflation in, 128 Asset-backed securities, 26 Auction-rate securities, 104 Bank of England, 63, 67, 85, 131 Bank of Japan, 85 Bankruptcy, 131, 132 Banks: Basel III bank liquidity regulations, 17; and fi xed-value floating-rate securities, 103, 106; regulation of, 67–68; reserve requirements for, 105 Barro, Robert, 2, 3, 127 Basel III bank liquidity regulations, 17 Benchmark yield curve, 26, 36, 76, 100–101, 111 Bernanke, Ben, 79, 80, 85–86 Bid-ask spreads, 94, 95, 107, 108 Billion Prices Project (MIT), 128 Bitcoin, 103 Borensztein, Eduardo, 130 Bremner, Robert, 83, 84 Bretton Woods system, 62 Budget volatility, Bulow, Jeremy, 132 Bureau of Labor Statistics (BLS), 128 Business cycle, 71, 74 Call options, 108–09, 112 Capital gains, 116, 117 Cecchetti, Stephen G., 81 Central banks: independence of, 80, 81, 85; and liquidity premia, 27; as nontaxable investor, 97, 120; and Taylor rule, 70 See also Federal Reserve Chain-weighted CPI, 128 Chairman of the Fed (Bremner), 83 Checking accounts, 104 Chile, liquid benchmark yield curve in, 26 157 158 Index Cochrane, John H., 35, 91, 105, 139, 140 See also Debt structure proposal Collateral, 91, 99, 107, 136 Commercial paper, 102, 104 Commodity-price shocks, 131 Consumer price index (CPI), 96, 126, 128 Corporate bonds, 26, 76, 110, 112, 131 Cost minimization objective, 27, 29, 30, 31, 34, 68, 92 Countercyclical monetary policy, 30 Counterparties, 136 Credit risk, 112 See also Default risk Crowding-out motive, 17–18 Crump, Richard K., 35 Cummins, Jason, 83 Deadweight costs of taxes, 2, 7, 8, 13 Debt management: aggregate demand management objective of, 15–16, 27, 29, 34, 45, 68; cost minimization objective of, 27, 29, 30, 31, 34, 68, 92; as fi nancial regulation tool, 16–18; financial stability objective of, 27, 29, 34, 37, 44–45, 68, 93; fiscal risk management objective of, 27, 29, 30, 34, 68; objectives of, 27, 68 Debt rollover crisis, 9–10 Debt structure proposal (Cochrane), 91–146; commentary on, 139–43; fi xed-coupon perpetuities, 94–95, 106–15; fi xed-value floating-rate securities, 93–94, 99–106; goals, 92–93; indexed perpetuities, 96, 126–29; nominal perpetuity, fi xed-coupon debt, 94; securities, 93–139; swaps, 97–98, 134–36; tax-free securities, 96–97, 115–25; variable-coupon debt, 97, 129–34 Debt-to-GDP ratio, 13, 14, 28–29, 71–72 Default-free short-term rate, 11–12 Default risk, 110, 112, 129, 132 Derivatives, 111 Direct Express, 102 Dividends, 131 Dornbusch, Rudiger, 80 Duffie, Darrell, 114, 139 Dybvig, Phillip H., 121 Eaton, Jonathan, 132 Eberly, Janice, 28 Endowments, 97, 120 Estate planning, 111, 118 “Even keeling” policy, 62 Exchange rates, 53 Fannie Mae, 47 Federal funds rate, 101 Federal Open Market Committee (FOMC), 72, 83 Federal Reserve: debt management confl icts with Treasury Department, 43–89; and debt-toGDP ratio, 71–72; and “even keeling” policy, 62; and fi xedvalue floating-rate debt, 103–04; Foreign Portfolio Holdings, 124–25; independence of, 84; and inflation-indexed debt, 23; and liquidity premia, 27, 70–71; and monetary policy cycle, 67–70; objectives of, 29, 36, 58, 72; and Operation Twist (1961), 62, 78; and optimal debt maturity, 67–70; optimal division of labor with Treasury, 67–75; and quantitative easing, 15; Treasury cooperation with, 58–67; and Treasury policy (2008–14), 45–58 Fedwire, 103 Ferguson, Niall, 25 Fernandez, Raquel, 132 Financial crisis (2008–09), 24, 28, 74 Financial regulation: of banks, 67–68; Basel III bank liquidity regulations, 17; debt management as tool for, 16–18 Index Financial stability: as debt management objective, 27, 29, 34, 37, 44–45, 68, 93; and fi xed-value floating-rate securities, 102 Fiscal risk: and average debt maturity, 44, 75; debt management objectives for, 3–4, 9, 13, 27, 29, 30, 34, 68; hedging of, 14–15; and inflationindexed debt, 23, 25; and liquidity services, 5; and maturity, 137 Fitted yields, 11 Fixed-coupon perpetuities, 94–95, 106–15; accounting for, 115; call options, 108–09; hedging with, 111–12; historical precedents, 109–10; and intermediate-maturity supply, 112–14; price impact of, 108; rationale for, 106–07; retail market for, 111–12; wholesale market for, 111–12 Fixed-value floating-rate debt, 93–94, 99–106; and credit, 106; Fed’s inability to provide, 103–04; and monetary policy, 104–05; and price-level determination, 104–05; rationale for, 101–03; setting rate for, 100–101 Fleckenstein, Matthias, 23 Flight-to-quality episodes, 13, 74 Floating-rate notes, 1, 77 Flow of Funds, 125 FOMC (Federal Open Market Committee), 72, 83 401(k) accounts, 117 See also Pension funds 403(b) accounts, 117 See also Pension funds France, debt management practices in, 63 Freddie Mac, 47 Friedman, Milton, 9, 101 Funding volatility, 30 G-7 countries, debt management practices of, 63–64, 76–77 See also specific countries 159 Geddie, John, 130 Geithner, Timothy, 85–86 Gensler, Gary, 5–6 Germany, debt management practices in, 63 Gorton, Gary B., 16 Goschen’s conversion, 109 Government National Mortgage Association (GNMA), 47 Great Recession, 43 See also Financial crisis (2008–09) Greece: debt crisis in, 130; GDPlinked debt in, 130 Greenwood, Robin, 1, 5, 7, 11–12, 13, 18, 24, 28, 32, 34, 43, 80, 81, 83, 86, 137, 139 Hamilton, Alexander, 109, 131 Hanson, Samuel G., 1, 5, 7, 11–12, 13, 18, 24, 28, 32, 34, 43, 80, 81, 83, 86, 137, 139 Hedging: of fiscal risks, 14–15; with fi xed-coupon perpetuities, 111–12; and inflation, 128, 138; “on-therun” Treasuries used for, 27 High-tax-rate investors, 124 Household consumption, Housing costs, 128 Indexed perpetuities, 96, 126–29; objections to, 128–29; rationale for, 126–27 Inflation: cost of, 133; and debt maturity structure, 22, 138; Federal Reserve mandate to manage, 36, 58; hedging against, 138; and monetary policy, 93; and Operation Twist (1961), 84; and swaps, 96; and variable-coupon debt, 129 Inflation-indexed debt, 1, 23–26 See also Treasury inflation-protected securities (TIPS) Insurance premium, 14 Interest costs, 118–19, 121–24 Interest rate risk, 4, 6–7, 47–49, 97, 138 160 Index Interest rate volatility, Intermediate-maturity supply, 1, 112–14 IRA accounts, 117 Italy, debt management practices in, 63 Japan: debt management practices in, 63, 77; liquidity trap in, 79; quantitative easing in, 85 Johnson, Lyndon B., 83–84 Kamstra, Mark J., 130 Kashyap, Anil K., 17 Kim, Don H., 22, 35, 55 Krishnamurthy, Arvind, 10, 13, 17, 139 Labor Department, 128 Large-scale asset purchase (LSAP) prices, 55 Libor rates, 101 Life insurance, 111 Liquidity premium: and cost minimization, 31; and debt maturity, 82; and Federal Reserve, 70–71; and fi xed-value floatingrate securities, 94; on nominal vs inflation-indexed debt, 24; for “on-the-run” Treasuries, 27; shifts in, 13; on short-term debt, 8, 9, 14; and swaps, 98; of Treasury bills, 3; and Treasury Department, 70–71 Liquidity services, Liquidity transformation, 17–18 Liquidity trap, 79 Long-horizon portfolio theory, 96 Longstaff, Francis A., 23 Long-term bonds, Lucas, Robert E., Jr., 101, 132 Lustig, Hanno, 23 Macaulay duration, 47 Macroeconomic stabilization See Financial stability Marginal deadweight costs of taxation, 7, 8, 13 Market access, 78 Martin, William McChesney, 83–84 Maturity of government debt, 1–41; aggregate demand and debt management, 15–16; commentary on, 28–37; debt counterfactuals, 18–22; debt management as financial regulatory tool, 16–18; debt management beyond maturity structure, 23–27; nominal vs inflation-indexed debt, 23–26; optimal structure of net consolidated government debt, 2–5; quantitative assessment, 18–22; trade-off model, 5–15 Mauro, Paolo, 130 MBSs See Mortgage-backed securities McCulley, Paul, 79 Metrick, Andrew, 16 Miller, Mary John, 76 Miller, Merton, 121, 124 Minsky Moment (2007–08), 79, 80 MIT Billion Prices Project, 128 Miyajima, Ken, 130 Modern portfolio theory, 127 Modigliani-Miller theorem, 99 Moench, Emanuel, 35 Monetary policy: and aggregate demand, 15; countercyclical, 30; and Federal Reserve, 67–70; and financial crisis (2008–09), 28; and fi xed-value floating-rate debt, 104–05; Friedman rule of, 9; and inflation, 93; and inflationindexed debt, 127; and maturity, 137; and Treasury Department, 67–70 Money-market funds, 102, 103, 104 Monthly Statement of the Public Debt, 50, 115 Mortgage-backed securities (MBSs), 26, 45, 47, 76, 110 Municipal bonds, 26, 76, 112, 123, 141 Index Mutual funds, 125 MyRA program, 116–17 Nagel, Stefan, 13 Nominal bonds, 23–26 Nonprofit corporations, 120 Office of Management and Budget (OMB), 18 “On-the-run” Treasuries, 27, 31 Operation Twist (1961), 62, 78, 84–85 Optimal debt maturity, 67–70 See also Maturity of government debt Overnight index swap (OIS) rate, 11–12 Overnight repurchase agreements, 102, 104 See also Repo market Pay.gov, 102 Pension funds, 97, 111, 120, 125 Pflueger, Carolin E., 23 Piazzesi, Monika, 35 Piketty, Thomas, 25 Policy coordination, 45, 58–75 See also Federal Reserve; Treasury Department Political economy, Portfolio balance effect, 16, 53 Potter, Simon, 95 Pozsar, Zoltan, 16 Prepayment options, 112 Price-level determination, 104–05 Price-stickiness, 133 Private sector: and fi xed-value floating-rate securities, 106, 142; and interest rate risk, 49, 98; liquidity transformation by, 17–18; short-term debt issuance by, See also Corporate bonds Quantitative easing (QE): and debt management policy, 15, 27, 32, 43–44, 82; duration impact of, 49–50, 53; and financial crisis (2008–09), 28; and financial stability, 93; stock price impact of, 161 53; as tool for managing aggregate demand, 4; in the United Kingdom, 63, 67 Ramanathan, Karthik, Refinancing risk, 8, 9, 15, 32, 44, 71 Regulation See Financial regulation Reinhart, Carmen, 25 Repo market, 32, 101, 102, 104 Reverse repurchase (RRP) agreements, 74 Ricardian equivalence, 2–3, 4, 19 Ricardo, David, Risk-free rates, 26 Risk management, 27 Risk premium, 6, 77 Rogoff, Kenneth, 132 Rollover risk, 32, 78 Romney, Mitt, 117 Ross, Stephen A., 121 Roth IRA, 117 RRP (reverse repurchase) agreements, 74 Rudolph, Joshua S., 1, 28, 32, 34, 43, 55, 80, 81, 83, 86, 137 Sack, Brian, 33 Sargent, Thomas, 79 Sbrancia, M Belen, 25 Scarcity premium, 113 Schaab, Andreas, 25 Schmitt-Grohé, Stephanie, 133 Schularick, Moritz, 25 Securities and Exchange Commission (SEC), 137 Shiller, Robert J., 130 Sims, Christopher, 133 Social Security, 128 Stein, Jeremy C., 5, 7, 11–12, 13, 16, 17, 18, 24, 54, 139 Stock prices, 53 Stokey, Nancy L., 132 STRIPs program, 111–12 Summers, Lawrence H., 1, 25, 28, 32, 34, 43, 80, 81, 83, 86, 137, 147 162 Index Swanson, Eric, 84 Swaps, 97–98, 111, 134–36 System Open Market Account (SOMA), 47, 49, 75 Tax-avoidance costs, 118, 119–20 Tax-clientele models, 121 Tax efficiency, 120–21 Taxes: deadweight costs of, 2, 7, 8, 13; debt management’s role in managing, 4; government financing via, Tax-free securities, 96–97, 115–25; analysis of, 118–25; and heterogeneous tax rates, 120–21; and interest costs, 118–19, 121–24; rationale for, 115–17; and taxavoidance costs, 119–20; and tax efficiency, 120–21; and Treasury debt taxation, 117–18 Taylor rule, 23, 70, 105 Ten-year duration equivalents, 49, 50, 51 Term premium, 7, 22, 29, 31, 32, 35 Terms of trade shocks, 131 Trade-off model, 5–15, 44 Trading costs, 94 Transaction costs, 24 Transactions services accounts, 103 Treasury Accord (1951), 10, 18, 61–62, 78 Treasury bills: liquidity of, 1, 3, 6, 11–12, 14; substitutes for, 74; supply fluctuations in, 13 Treasury Borrowing Advisory Committee, 10, 44, 140 Treasury Department: debt management conflicts with Federal Reserve, 43–89; Debt Management Office, 139; and debt-to-GDP ratio, 71–72; Fed cooperation with, 58–67; and Fed policy (2008–14), 45–58; and liquidity premia, 70–71; and monetary policy cycle, 67–70; objectives of, 34, 37; and Operation Twist (1961), 62, 78; and optimal debt maturity, 67–70; optimal division of labor with Fed, 67–75 Treasury Direct, 102 Treasury inflation-protected securities (TIPS), 23, 24, 96, 117, 126–27, 129 Truman, Harry S., 61 United Kingdom: debt management practices in, 63, 67, 77, 85; fiscal stress in, 130, 133; fi xed-coupon perpetuities in, 109; inflationindexed debt in, 23, 127; quantitative easing in, 85 Uribe, Martín, 133 Variable-coupon debt, 97, 129–34; economic analysis of, 132–34; rationale for, 129–30; rules for, 130–31 Viceira, Luis M., 23 Vissing-Jorgensen, Annette, 10, 13, 17, 139 Volcker, Paul, 84 Wallace, Neal, 140 Weighted average maturity, 47, 115, 143 Williams, John C., 51 Woodford, Michael, 105 Wright, Jonathan H., 22, 35, 55 Yield curve, 59, 76, 112, 113, 142, 143 Zero-coupon bonds, 111, 112, 113–14, 128 What is the best way for the U.S Treasury to finance the federal government’s huge debt? E veryone talks about the size of the national debt: now at $13 trillion and climbing Few talk about how the Treasury does the borrowing, even though it is one of the world’s largest borrowers Yet everyone from bond traders to the home-buying public is affected by the Treasury’s decisions about whether to borrow short or long term and what types of bonds to sell to investors In The $13 Trillion Question, Harvard’s Robin Greenwood, Sam Hanson, Joshua Rudolph, and Larry Summers argue that the Treasury could save taxpayers money and help the economy by borrowing more short term and less long term They also argue that the Treasury and the Federal Reserve made a huge mistake in recent years by rowing in opposite directions: while the Fed was buying long-term bonds to push investors into other assets, the Treasury was doing the opposite—selling investors more long-term bonds The Hoover Institution’s John Cochrane joins the discussion by suggesting a series of new and innovative ways for Treasury to finance the debt Each chapter of The $13 Trillion Question includes responses from a variety of public and private sector experts on how the Treasury does its borrowing Larry Summers offers concluding comments with a call for the policy community to pay greater attention to debt management “Debt management is too important to leave to the debt managers,” he says DAVID WESSEL is director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution and a contributing correspondent to the Wall Street Journal, where he was an editor, columnist, and reporter for thirty years BROOKINGS INSTITUTION PRESS Washington, D.C www.brookings.edu/press COVER BY NANCY BRATTON .. .The $13 Trillion Question The $13 Trillion Question How America Manages Its Debt David Wessel EDITOR BROOKINGS INSTITUTION PRESS Washington, D.C Copyright © 2016 THE BROOKINGS... those of the authors Library of Congress Cataloging-in-Publication data Names: Wessel, David, editor Title: The $13 trillion question : how America manages its debt / David Wessel, editor Other titles:... for lowering the average maturity of the debt. 7 Turning to the other side of the trade-off, the government also seeks to minimize fiscal risk, meaning that the cost of servicing the debt should