Download GOVERNMENT DEBT MANAGEMENT AT THE ZERO LOWER

GOVERNMENT DEBT MANAGEMENT
AT THE ZERO LOWER BOUND
SEPTEMBER 30, 2014
ROBIN GREENWOOD
GEORGE GUND PROFESSOR OF FINANCE & BANKING, HARVARD BUSINESS SCHOOL
SAMUEL G. HANSON
ASSISTANT PROFESSOR, HARVARD BUSINESS SCHOOL
JOSHUA S. RUDOLPH
MASTER IN PUBLIC POLICY, HARVARD KENNEDY SCHOOL OF GOVERNMENT
LAWRENCE H. SUMMERS
CHARLES W. ELIOT UNIVERSITY PROFESSOR, HARVARD UNIVERSITY
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
PULLING IN OPPOSITE DIRECTIONS
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
20%
15%
10%
The Fed’s Quantitative Easing (QE)
policies have reduced the net supply
of long-term securities.
5%
0%
Fed QE:
Treasuries,
Agencies and
MBS
-5%
-10%
-15%
-20%
2007
QE1
2008
QE2
2009
2010
Twist
2011
QE3
2012
2013
15.6%
PULLING IN OPPOSITE DIRECTIONS
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
20%
15%
10%
Meanwhile the Treasury was doing
the opposite, extending the average
maturity of its borrowings.
Treasury:
Maturity Extension
5%
5.6%
0%
Fed QE:
Treasuries,
Agencies and
MBS
-5%
-10%
-15%
-20%
2007
QE1
2008
QE2
2009
2010
Twist
2011
QE3
2012
2013
PULLING IN OPPOSITE DIRECTIONS
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
20%
15%
Treasury:
Maturity Extension
10%
5%
0%
Fed QE:
Treasuries,
Agencies and
MBS
-5%
-10%
-15%
-20%
2007
QE1
2008
QE2
2009
2010
Twist
2011
QE3
2012
2013
Net
Impact:
10.1%
PULLING IN OPPOSITE DIRECTIONS
10-year duration equivalents, Change since Dec. 31, 2007
(% of GDP)
30%
24.9%
10-year equivalents, % of GDP
20%
Treasury:
Rising
Debt Stock
10%
5.5%
Maturity Extension
0%
Fed QE
-10%
15.6%
-20%
2008
2009
2010
2011
2012
2013
2014
MARKET IMPACT
Relying on prior studies, we estimate that
the Fed’s QE policies have lowered the
yield on 10-year Treasuries by a
cumulative 1.37 percentage points.
Thus, Treasury’s maturity extension may
have offset as much as one-third of QE’s
market impact.
FED VS. 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%
Treasury
% of GDP
75%
50%
> 5y
1-5y
25%
< 1y
0%
1943
> 5y
1950
1957
1964
1971
1978
1985
1992
1999
2006
1-5y
2013
Fed
-25%
1936
< 1y
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
Shorter-term
Limit fiscal risk
Longer-term
TRADITIONAL DEBT MANAGEMENT
Issuing short-term is “cheaper” because it allows
Treasury to capture the “liquidity premium” on Tbills and to conserve on the “term premium”
investors
demand
to hold
long
bonds.
Liquidity premium
on short-term
T-bills,
Basis
points
200
bps
150
100
50
0
2002
2004
2006
2008
2010
2012
2014
Term Premium on 10-Year Zero-Coupon Treasuries
(1990 to 2014)
-1 .0
QE3
Twist
QE2
QE1
3.0
199 0
199 1
199 2
199 3
199 4
199 5
199 6
199 7
199 8
199 9
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
%
TRADITIONAL DEBT MANAGEMENT
2.0
1.0
0.0
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
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
TRADITIONAL DEBT MANAGEMENT
Thus, Treasury has historically tended to extend
the average maturity of the debt when debt-toGDP rises. Much like the Treasury is doing today.
120%
100%
80%
60%
40%
20%
0%
1936
1943
1950
1957
1964
1971
Long-term share Treasury
1978
1985
1992
Debt/GDP
1999
2006
2013
QUANTIFYING FISCAL RISK: 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
TRADITIONAL DEBT MANAGEMENT
Low cost financing
Shorter-term
Limit fiscal risk
Longer-term
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
DEBT MANAGEMENT CONFLICTS
Objectives of modern debt management have
been assigned to Treasury and Fed, which exercise
different policy weights
Limit fiscal risk
Treasur
Fed Financial
y
stability
FedAggregate
demand
Treasur
Low cost
y
Shorter-term
Longer-term
DEBT MANAGEMENT CONFLICTS
• 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
• Contractionary monetary policy
• Rise in premium on money-like assets
• Increases incentive to issue short
• In this case, Treasury-led debt management is expansionary
SOLVING THE 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
•
Better solution: 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