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A New Structure for U.S. Federal Debt 139 But the fact that many issues are not pressing makes this moment an ideal one to restructure federal debt. The calm before the storm is a good time to fix the sails. COMMENT Darrell Duffie John Cochrane’s proposal for simplifying the debt management of the United States Treasury is original and radical. In its essence, the plan calls for the issuance of only two securities: floating-rate perpetual debt and fixed-rate perpetual debt. This is not merely a proposal for two general “classes” of debt securities. The proposal means literally that Treasury would issue, and keep reissuing over and over, the same two securities, forever! The only issuance decision to be made by Treasury’s debt management office would be how much more of each of these same two securities to issue or retire , day by day. Cochrane extends the basic two-security issuance menu by adding their inflation-indexed versions, and considers other possible extensions that I will discuss. I applaud Cochrane’s audacity, clear vision, and goal of simplifying debt management, among other objectives that I do not have space to discuss here. However, his plan is not cost-effective. As I will explain, this extreme restriction on the maturity distribution of outstanding Treasuries would impose a significant cost to the many market participants who have narrow preferences for the maturities of the Treasuries that they choose to own or short. The aversion to owning perpetuals rather than specific-maturity issues would also be reflected in a higher cost to taxpayers for funding the U.S. government. These maturity preferences, sometimes called clientele effects , have been described in prior work—for example Greenwood, Hanson, and Stein (2010) and Krishnamurthy and Vissing-Jorgensen (2012). Most of the relevant literature focuses on preferences only between short-maturity and long-maturity debt, which in principle would be met by Cochrane’s stark two-security menu, but the same clientele and liquidity effects 140 J. H. Cochrane described in the prior literature apply to distinctions among many different maturities. I don’t expect much support by market participants for Cochrane’s proposal . Both the sell-side and the buy-side of Treasury markets would be apoplectic at the prospect of losing access to large supplies of specific-maturity issues in amounts that are sensitive to their demands for hedging and speculation , especially in light of limits on the liquidity of secondary markets for Treasuries and Treasury repos. Currently, the Treasury Department is somewhat attentive to the demands of the market for Treasury securities of different maturities in different respective total amounts. To this end, Treasury seeks advice from primary dealers and bodies such as the Treasury Borrowing Advisory Committee. As I will explain, Treasury also infers directly from price signals and daily reports of Treasury delivery failures which particular securities are in especially high demand. Treasury responds by issuing more of those and less of others. Is the U.S. Treasury wasting its time (or even, as Cochrane argues, causing social harm) by catering to the maturity-based demands of Treasury investors? No, it is not. In an ideal frictionless-market world, as first shown by Wallace (1981), the maturity structure of government debt is irrelevant.12 All that matters to the real economy is the stream of net cash flows to be spent by the government. The economic effect of any issuance strategy for government liabilities could be costlessly converted by the private sector in this ideal world to the effect of any other issuance strategy that leaves the government with the same net stream of cash flows, through frictionless trading of a full menu of financial contracts. The Cochrane proposal would at least allow a perpetual fixed-rate note to be “stripped” into a portfolio of coupon-only claims and a forward claim to a perpetual. For example, a perpetual note could be converted to a stream of daily coupon payments for the next ten years and a claim to a perpetual note that starts paying in ten years. Ideally, one could synthesize any desired hypothetical fixed-rate Treasury by packaging the coupon strips accordingly. But the key problem here is not the ability to synthesize a desired position, but rather the available total free float of specific types of notes. 12. Other relevant pieces of this literature include Angeletos (2002), Chamley and Polemarchakis (1984), and Stiglitz (1988). A New Structure for U.S. Federal Debt 141 As...


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