Fiscal Insurance and Debt Management in OECD Economies

2 Measures of Fiscal Insurance

We propose two distinct classes of indicators for the performance of debt management. The Hrst
are motivated by implications from the tax smoothing literature while the second are based around
the period by period budget constraint, namely :

MV_w = ω_t+1 + R_t+ιMV_t

or                                                      (1)

MVt+ι = _ω*+ι + Rt*+ιMV/

where MV_t+₁ denotes the market value of government debt, ω_t+₁ denotes the primary deHcit and
R_t+1 is the gross one period holding return on government debt i.e. including both coupon payments
and capital gains. MV* and ω* denote the ratio of debt and deHcits to GDP respectively and R* ∣∣
is the growth adjusted interest rate (R_t+₁Y_t∕Y_t+₁}.

2.1 Tax Smoothing Perspective

A key insight of Lucas and Stokey (1983) is that time variation in the returns on assets held by
government can reduce the need for changes in tax rates. This suggests debt management can be
used to reduce the deadweight loss arising from distortionary taxation. Building on this insight,
Bohn (1990) uses the tax smoothing framework of Barro (1979) and derives Hrst order conditions
that the returns on debt instruments have to meet to support optimal Hscal policy. In a similar
vein Farhi (2005) outlines a government CAPM model based on a securities mean return and its
covariance with the excess burden of taxation and the marginal utility of consumption. While these
approaches have the advantage of focusing on individual funding instruments they also require joint
assumptions concerning optimal taxation, functional forms and the unobserved excess burden of
taxation. For these reasons we take a di≡erent approach to assessing the quality of debt management
and use the results of Marcet and Scott (2004) and derive measures depending on the aggregate
measure of debt.

Marcet and Scott (2004) analyze the case of a Ramsey planner who maximizes consumer welfare
under two di≡erent bond market scenarios. In one case governments have access to complete markets

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