Public Debt Management and the Term Structure of Interest Rates

This paper uses a stochastic overlapping generations model to answer the following question: How does the way the government structure its debt affect the term structure of interest rates? The analysis shows that the critical factor in determining the impact of public debt management on the term structure of interest rates is the way the induced changes in taxes and the supply of bonds affect (i) the agents’ possibilities to transfer resources intertemporally and (ii) the intergenerational distribution of wealth. It is also shown that, due to the fact that the term structure premium reflects the correlation between the buyers’ and sellers’ wealth, the effect on the term structure premium of a certain debt management policy might depend on the initial sign of the term structure premium.