Dallal Bendjellal

I study the problem of optimal public debt maturity in an economy in which the government cannot issue state-contingent debt and public debt serves as collateral for private agents. When private agents are not financially constrained, the government is able to fully insulate the economy against public spending shocks by issuing long term bonds and investing short term. This is because the market value of outstanding long-term debt decreases when public spending and thus interest rates rise. I find that this conclusion is not robust to the introduction of a collateral friction. When private agents use government debt as collateral for their liquidity needs, the government finds it optimal to issue short-term bonds along with long-term debt. While long-term debt provides a hedging benefit against shocks, short-term debt eases the financial constraint as the value of long-term debt in the collateral declines.