Government Debt Management at the Zero Lower Bound: A Roundtable Discussion

 
R
OBIN
 G
REENWOOD
, S
AMUEL
 G. H
ANSON
,
J
OSHUA
 S. R
UDOLPH
, & L
AWRENCE
 H. S
UMMERS
 
G
OVERNMENT
 D
EBT
 M
ANAGEMENT
AT
 
THE
 Z
ERO
 L
OWER
 B
OUND
 
2014 R
OUNDTABLE
 
ON
 T
REASURY
 M
ARKETS
A
ND
 D
EBT
 M
ANAGEMENT
 
I.
Quantify Fed vs. Treasury conflict in QE era
 
II.
Fed vs. Treasury in historical perspective
 
III.
A modern framework for debt management
 
IV.
Ways to resolve Fed vs. Treasury conflict
O
UR
 P
APER
 
Q
E
3
 
Q
E
1
 
Q
E
2
 
T
w
i
s
t
 
15.6%
 
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
 
The Fed’s Quantitative Easing (QE)
policies have reduced the net supply of
long-term securities.
 
P
ULLING
 
IN
 O
PPOSITE
 D
IRECTIONS
 
Q
E
3
 
Q
E
1
 
Q
E
2
 
T
w
i
s
t
 
5.6%
 
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
 
 
Meanwhile the Treasury was doing the
opposite, extending the average
maturity of its borrowings.
 
P
ULLING
 
IN
 O
PPOSITE
 D
IRECTIONS
 
Q
E
3
 
Q
E
1
 
Q
E
2
 
T
w
i
s
t
 
Net
Impact:
10.1%
 
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
 
P
ULLING
 
IN
 O
PPOSITE
 D
IRECTIONS
 
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
 
P
ULLING
 
IN
 O
PPOSITE
 D
IRECTIONS
 
 
 
Before 2008, the Fed’s balance sheet was far
smaller. As a result, the Fed had little impact on
the maturity structure of the government’s
consolidated debts.
 
F
ED
 
VS
. T
REASURY
 H
ISTORICALLY
 
Shorter-term
 
Longer-term
 
  
Low cost financing
 
Limit fiscal risk
 
T
RADITIONAL
 D
EBT
 M
ANAGEMENT
 
Treasury’s traditional approach to determining the
appropriate maturity of the debt traded off a desire to
achieve 
low cost financing
 against the desire to 
limit
fiscal risk
.
 
T
RADITIONAL
 D
EBT
 M
ANAGEMENT
 
Issuing short-term is “cheaper” because it allows
Treasury to capture the “liquidity premium” on T-bills
and to conserve on the “term premium” investors
demand to hold long bonds.
 
Liquidity premium on short-term T-bills, Basis points
 
T
RADITIONAL
 D
EBT
 M
ANAGEMENT
 
Term Premium on 10-Year Zero-Coupon Treasuries
(1990 to 2014)
 
T
RADITIONAL
 D
EBT
 M
ANAGEMENT
 
What is fiscal risk?
 
Refinancing risk
If the government issues short-term, it is exposed to increases in
interest rates
If the government issues long-term, it ‘locks in’ the cost of capital
 
Rollover risk
Failed auction
Self-fulfilling bank run
 
Shorter-term
 
Longer-term
 
 Low cost financing
 
 
Limit fiscal risk
 
T
RADITIONAL
 D
EBT
 M
ANAGEMENT
 
The desire to 
limit fiscal risk
 looms larger when the
overall debt  burden rises.
 
T
RADITIONAL
 D
EBT
 M
ANAGEMENT
 
Thus, Treasury has historically tended to extend the
average maturity of the debt when debt-to-GDP rises.
Much like the Treasury is doing today.
 
Actual Path of Deficits
 
Deficits in Counterfactual Case
in which Treasury rolled over 3-mo Bills
 
Q
UANTIFYING
 F
ISCAL
 
RISK
: A C
OUNTERFACTUAL
 
We argue that the “fiscal risk” generated by issuing short-term
debt is less important than traditionally thought.
 
Shorter-term
 
Longer-term
 
  
Low cost financing
 
Limit fiscal risk
 
T
RADITIONAL
 D
EBT
 M
ANAGEMENT
 
Shorter-term
 
Longer-term
 
 Low cost
 
Limit fiscal risk
 
M
ODERN
 D
EBT
 M
ANAGEMENT
 
Modern debt management recognizes that the maturity of
government debt  may also be a valuable tool for 
managing
aggregate demand
 and 
promoting financial stability
.
 
 Aggregate demand
 
Financial stability
 
Shorter-term
 
Longer-term
 
 Low cost
 
Limit fiscal risk
 
D
EBT
 M
ANAGEMENT
 C
ONFLICTS
 
 Aggregate demand
 
Financial stability
 
Fed
 
Fed
 
Treasury
 
Treasury
 
Objectives of modern debt management have been delegated to
Treasury and Fed, which assign different policy weights to
potentially conflicting goals
 
Outside of the zero-lower-bound, Fed sterilization of
Treasury debt management is imperfect workaround
Fed gets last word using short rate
But sterilization no longer possible at the ZLB
Expansionary monetary policy at ZLB
Extend average duration to mitigate fiscal risk (Treasury)
Shorten average duration to bolster aggregate demand (Fed)
Fed and Treasury in direct conflict over objectives
If all weight on Fed’s objective function, then Fed can
presumably do more QE
Realistically, dollar amount of QE limited by political
considerations
 
D
EBT
 M
ANAGEMENT
 C
ONFLICTS
 
Treasury and Fed release annual joint statement on
combined public debt management strategy
Forces each agency to internalize other’s objectives
Fed charged with routine tactical adjustments because
of its expertise in open-market operations
Our proposal is NOT in conflict in any way with Fed
independence, if anything it seeks to bolster it
Our proposal similar in nature to the cooperation
between UK DMO and BOE starting in 2009
Mervyn King “
If the facility were to be used to purchase gilts, it would be
important that the Government’s debt management policy remain consistent
with the aims of monetary policy….I should be grateful if you could confirm
that this will be the case.”
B
ETTER
 
SOLUTION
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This roundtable discussion in 2014 focused on the conflict between the Federal Reserve and the Treasury in managing government debt, particularly in the era of Quantitative Easing (QE). It explores the historical perspectives, a modern debt management framework, and potential solutions to resolve this conflict. The visuals presented show how the Fed's QE policies have impacted the supply of long-term securities, contrasting with the Treasury's actions in extending the average maturity of its borrowings.


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  1. GOVERNMENT DEBT MANAGEMENT ATTHE ZERO LOWER BOUND 2014 ROUNDTABLEON TREASURY MARKETS AND DEBT MANAGEMENT ROBIN GREENWOOD, SAMUEL G. HANSON, JOSHUAS. RUDOLPH, & LAWRENCE H. SUMMERS

  2. OUR PAPER I. Quantify Fed vs. Treasury conflict in QE era II. Fed vs. Treasury in historical perspective III. A modern framework for debt management IV. Ways to resolve Fed vs. Treasury conflict

  3. PULLINGIN OPPOSITE DIRECTIONS 10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) The Fed s Quantitative Easing (QE) policies have reduced the net supply of long-term securities. 20% 15% 10% 5% 0% Fed QE: Treasuries, Agencies and MBS -5% 15.6% -10% -15% QE1 QE2 Twist QE3 -20% 2007 2008 2009 2010 2011 2012 2013

  4. PULLINGIN OPPOSITE DIRECTIONS 10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) Meanwhile the Treasury was doing the opposite, extending the average maturity of its borrowings. 20% 15% Treasury: Maturity Extension 10% 5% 5.6% 0% Fed QE: Treasuries, Agencies and MBS -5% -10% -15% QE1 QE2 Twist QE3 -20% 2007 2008 2009 2010 2011 2012 2013

  5. PULLINGIN OPPOSITE DIRECTIONS 10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) 20% 15% Treasury: Maturity Extension 10% 5% Net Impact: 10.1% 0% Fed QE: Treasuries, Agencies and MBS -5% -10% -15% QE1 QE2 Twist QE3 -20% 2007 2008 2009 2010 2011 2012 2013

  6. PULLINGIN OPPOSITE DIRECTIONS 10-year duration equivalents, Change since Dec. 31, 2007 (% of GDP) 30% 24.9% 20% Treasury: Rising Debt Stock 10-year equivalents, % of GDP 10% 5.5% Maturity Extension 0% Fed QE -10% 15.6% -20% 2008 2009 2010 2011 2012 2013 2014

  7. FEDVS. TREASURY HISTORICALLY Before 2008, the Fed s balance sheet was far smaller. As a result, the Fed had little impact on the maturity structure of the government s consolidated debts. 100% 75% Treasury 50% % of GDP > 5y 1-5y 25% < 1y 0% 1-5y < 1y > 5y Fed -25% 1936 1943 1950 1957 1964 1971 1978 1985 1992 1999 2006 2013

  8. TRADITIONAL DEBT MANAGEMENT Treasury s traditional approach to determining the appropriate maturity of the debt traded off a desire to achieve low cost financing against the desire to limit fiscal risk. Low cost financing Limit fiscal risk Shorter-term Longer-term

  9. TRADITIONAL DEBT MANAGEMENT Issuing short-term is cheaper because it allows Treasury to capture the liquidity premium on T-bills and to conserve on the term premium investors demand to hold long bonds. Liquidity premium on short-term T-bills, Basis points 200 150 bps 100 50 0 2002 2004 2006 2008 2010 2012 2014

  10. TRADITIONAL DEBT MANAGEMENT Term Premium on 10-Year Zero-Coupon Treasuries (1990 to 2014) Twist QE2 QE3 QE1 3.0 2.0 1.0 % 0.0 -1.0 1991 1997 1993 1992 1996 1999 1994 2001 2007 1995 1998 2003 2002 2009 2004 1990 2006 2008 2005 2000 2011 2014 2010 2013 2012

  11. TRADITIONAL DEBT MANAGEMENT What is fiscal risk? Refinancing risk If the government issues short-term, it is exposed to increases in interest rates If the government issues long-term, it locks in the cost of capital Rollover risk Failed auction Self-fulfilling bank run

  12. TRADITIONAL DEBT MANAGEMENT The desire to limit fiscal risk looms larger when the overall debt burden rises. Low cost financing Limit fiscal risk Shorter-term Longer-term

  13. TRADITIONAL DEBT MANAGEMENT Thus, Treasury has historically tended to extend the average maturity of the debt when debt-to-GDP rises. Much like the Treasury is doing today. 120% 100% 80% 60% 40% 20% 0% 1936 1943 1950 1957 1964 1971 1978 1985 1992 1999 2006 2013 Long-term share Treasury Debt/GDP

  14. QUANTIFYING FISCALRISK: A COUNTERFACTUAL We argue that the fiscal risk generated by issuing short-term debt is less important than traditionally thought. Deficits in Counterfactual Case in which Treasury rolled over 3-mo Bills Actual Path of Deficits

  15. TRADITIONAL DEBT MANAGEMENT Low cost financing Limit fiscal risk Shorter-term Longer-term

  16. MODERN DEBT MANAGEMENT Modern debt management recognizes that the maturity of government debt may also be a valuable tool for managing aggregate demand and promoting financial stability. Limit fiscal risk Financial stability Aggregate demand Low cost Shorter-term Longer-term

  17. DEBT MANAGEMENT CONFLICTS Objectives of modern debt management have been delegated to Treasury and Fed, which assign different policy weights to potentially conflicting goals Limit fiscal risk Treasury Fed Fed Financial stability Aggregate demand Treasury Low cost Shorter-term Longer-term

  18. DEBT MANAGEMENT CONFLICTS Outside of the zero-lower-bound, Fed sterilization of Treasury debt management is imperfect workaround Fed gets last word using short rate But sterilization no longer possible at the ZLB Expansionary monetary policy at ZLB Extend average duration to mitigate fiscal risk (Treasury) Shorten average duration to bolster aggregate demand (Fed) Fed and Treasury in direct conflict over objectives If all weight on Fed s objective function, then Fed can presumably do more QE Realistically, dollar amount of QE limited by political considerations

  19. BETTERSOLUTION Treasury and Fed release annual joint statement on combined public debt management strategy Forces each agency to internalize other s objectives Fed charged with routine tactical adjustments because of its expertise in open-market operations Our proposal is NOT in conflict in any way with Fed independence, if anything it seeks to bolster it Our proposal similar in nature to the cooperation between UK DMO and BOE starting in 2009 Mervyn King If the facility were to be used to purchase gilts, it would be important that the Government s debt management policy remain consistent with the aims of monetary policy .I should be grateful if you could confirm that this will be the case.

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