Fiscal Insurance and Debt Management in OECD Economies

This situation might occur for economies where as debt rises investors demand a higher risk premia
so that funding costs actually rise when the dehcit increases. Although in our analysis we focus on
calculating Φ^ in terms of the response of debt and dehcit to dehcit shocks the approach can easily
be extended to consider the degree of hscal insurance provided against shocks to GDP, inhation,
etc.

3 Tax Smoothing or Debt Stabilization?

The previous sections outlined a range of potential performance indicators for debt management
drawn from two diherent motivations - tax smoothing, where the role of debt management is to
minimise huctuations in the excess burden of taxation, and debt stabilization, where debt manage-
ment exploits negative covariances between bond prices and primary dehcits to ohset the impact
of dehcit huctuations on the level of debt. Only if huctuations in debt are correlated with huctu-
ations in the excess burden of taxation should we expect these motivations to produce the same
assessment of debt management performance. In this section we perform simulations to consider
the relationship between debt stabilization and optimal taxation and the implications for our two
sets of indicators. Our aim is to investigate whether the indicators motivated by debt stability
issues would also perform well in a tax smoothing context and more generally to understand the
relationship between tax smoothing and debt stability and the role of debt management in linking
the two.

In order to do this we take a canonical Real Business Cycle model where a Ramsey planner sets
taxes to minimise their distortionary costs and does so in both a complete and incomplete market
scenario. Later we will use these simulations to record the efficacy of our performance indicators
but in this section we are focusing on the link between debt stability and debt management.

Our model economy consists of a consumer with utility function :
where c_t, l_t denote consumption and leisure respectively. We set B so that the share of leisure in the
time endowment equals 30% on average, use a discount factor of 0.98 and set 7ι=l, 72=2. Output

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