Fiscal Insurance and Debt Management in OECD Economies

the same relative order. However for many of the measures inspired by debt stability there
is a normalization issue such that the absolute size of a statistic may not be indicative of
the presence or otherwise of high quality debt management. However, for a given economic
structure we can interpret lower measures for our performance indicator as reflecting better
quality debt management from both a tax smoothing and debt stability perspective.

4 Evaluating Performance Indicators

In this section we use simulations of our models to assess the ability of our 7 different indicators of
debt management performance (3 motivated by tax smoothing - two relative persistence measures
and the impact test; 4 motivated by debt stabilization - correlation coefficient between deficits and
bond prices; two measures of relative standard deviations and the dynamic measure of the extent
to which debt is insulated against deficit shocks). We do so by solving under both complete and
incomplete markets and then examine the ability of these indicators to discriminate successfully
between the two cases. We know from the previous section that for a given economy complete
markets produce debt that is more swiftly mean reverting than under incomplete markets. There-
fore, indicators that successfully detect the difference between complete and incomplete markets
will also discriminate debt management policies that produce more stable levels of debt.

In performing these simulations we abstract from two key issues. Firstly, we consider only real
and not nominal denominated debt and secondly we consider the case where the government is able
to implement the Ramsey outcome due to full commitment. In practice governments issue nominal
debt (and in our later empirical results we use real data for debt, deficits and GDP). As suggested
by Benigno and Woodford (2003) this raises the possibility that even if governments issue fixed rate
nominal securities through variations in inflation the complete market outcome can be achieved. In
our empirical analysis we allow for this possibility by examining the role of inflation and inflation
volatility in influencing the degree of fiscal insurance achieved. Introducing nominal debt also opens
the possibility that the existence of nominal imperfections will require governments to trade off the
tax smoothing possibilities of inflation against the need to reduce other distortions. If this were the
case then we might well find in the data that governments achieve limited fiscal insurance through

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