Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure

How should the tax rate and the level of public debt adjust to an adverse fiscal shock? What is the optimal maturity structure of public debt? If the maturity structure is carefully chosen, the ex post variation in the market value of public debt can cover the government against the need to raise taxes or debt if fiscal conditions should turn bad. In general, almost every Arrow-Debreu allocation can be implemented with noncontingent debt of different maturities. In a stylized example, the optimal policy is implemented by selling a perpetuity and investing in a short-term asset. © 2001 the President and Fellows of Harvard College and the Massachusetts Institute of Technology