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DEBT MANAGEMENT POLICIES
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Chapter 1
General Economic Concepts
Chapter 2
What is Policy?
Chapter 3
History of Macroeconomic Policies in the United States
Chapter 4
Policy Goals: Maximum Employment
Chapter 5
Policy Goals: Maximum Production
Chapter 6
Policy Goals: Price Stability
Chapter 7
Policy Goals: External Balance
Chapter 8
Subsidiary Policy Goals
Chapter 9
Conflicting Policy Goals
Chapter 10
The Policy Makers
Chapter 11
The Policy Instruments
Chapter 12
The Decision-Making Processes
Chapter 13
The Policy Indicators
Chapter 14
The General Economic Model
Chapter 15
Monetarist Monetary and Fiscal Policies
Chapter 16
Keynesian Monetary and Fiscal Policies
Chapter 17
Debt Management Policies
Chapter 18
Incomes Policies
Chapter 19
Supply Management Policies
Chapter 20
The Long Wave
Chapter 21
Contemporary Issues
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[author]

  1. Introduction
  2. Budget Deficits
  3. The Public Debt
  4. Debt Management Tools
  5. The Yield Curve
  6. Debt Management Policies
  7. Debt Management Practices
  8. Summary
    Readings
    Websites
top    I. Introduction

The Federal government has two types of debt that it must fund. The first type is the debt incurred to finance current federal budget deficits. When the federal government wants to spend more than it receives in revenue, it must offer securities for sale to finance its excess expenditures. The second type is the debt incurred to refinance maturing debt. When portions of the existing public debt mature, the federal government must decide if it will retire the old securities or refund them with the proceeds from the sale of new securities. Refunding is often referred to as a "rollover" or "rolling over the old debt". Debt management is the federal government's practice of borrowing with securities of different maturities to influence economic activity, generally by altering the term structure of interest rates.

top    II. Budget Deficits

Each year, the federal government takes in revenue, primarily from tax collections. The primary sources of tax collections are personal income taxes, payroll taxes for social insurance, and corporate income taxes. Each of these is tied in one or another ways to nominal GNP. Throughout the 1970s individuals and corporations were subject to bracket creep. As inflation pulled up nominal GNP, individuals and corporations were pulled into higher tax brackets without any increase in real income. During the 1960s, tax revenue increased by 109% from $92.5 billion to $193.7 billion, but during the 1970s, tax revenue jumped by 167% from $193.7 billion to $517.1 billion. Bracket creep substantially increased nominal tax collections for the government and allowed it to spend more; but, even with tax revenue increases, spending ran far ahead of tax collections. During the 1960s, government expenditure increased by 113% from $92.2 billion to $196.6 billion, but during the 1970s, government expenditure jumped by over 200% from $196.6 billion to $590.9 billion. By 1980, the annual deficit had reached $73.8 billion. The main theme of the 1980 Presidential election was "budget balance."

THE U.S. FEDERAL BUDGET DEFICIT
deficit
The 1980 election, however, was not the end of the deficits. Following President Reagan's election, two things happened. First, at Reagan's request, Congress passed the 1981 Economic Recovery Tax Act, which lowered marginal tax rates, accelerated depreciation allowances, and indexed tax brackets. Second, the economy went into recession. Third, the Congress and the President failed to cut expenditures. The combination of events reduced tax revenue for the federal government, while expenditure continued to grow. In FY 1983, the federal budget deficit topped $300 billion. In FY 1989, the deficit dropped back to $200 billion, but by FY 1991, it was back over $300 billion. Since 1991, the deficit has declined continuously. For FY 1996, the annual deficit dropped to just over $100 billion and, by the end of FY 1998, the government actually reported a surplus of $70 billion. This was the first budget surplus in almost thirty (30) years, since 1969.

The budget surpluses continued through FY 2001. During 2001, Congress passed the Tax Reduction Act of 2001 which reduced marginal tax rates across-the board. In the summer of 2001, the economy began to slow down. Much spending by businesses on new computer and telecommunications technologies and upgrades for Y2K was complete. In September 2001, the world Trade Center was attacked. As a result, tax revenue decreased while spending increased and the budget returned to deficit in 2002. These deficits increased both in absolute size and as a percentage of GDP through the mid-2000s.

Then, in 2007, a financial crisis in the housing market precipitated the worst post-WW II contraction. The Bush Administration oversaw passage of the Troubled Asset Relief Program (TARP) in October 2008, which authorized $780 billion to buy up troubled assets from bank balance sheets and restore capital cushions to financial institutions that bought derivative mortgage securities. Within six months, the Obama Administration oversaw passage of the American Recovery and Reinvestment Act (ARRA) in March 2009, which authorized the government to spend another $787 billion, this time on jobs creation. By fiscal 2009, the federal budget deficit had climbed to $1.4 trillion.

Every time the federal government fails to collect enough tax revenue to pay for its expenditure, it must borrow. When it does so, it borrows in the open market by issuing securities (Treasury IOUs). The cumulation of unpaid deficits is the public or national debt.

top    III. The Public Debt

The public debt is the sum of all past deficits minus any redemptions or retirements. When securities issued to pay for deficits in past years mature, the government has two choices. Either it may run a surplus to redeem the debt with excess tax revenue or it may refinance the maturing debt by issuing new securities. If it chooses to redeem or retire the debt, the debt declines. If it chooses to refinance the debt, the debt remains the same. If it runs an additional budget deficit, the debt increases.

THE U.S. GROSS AND PUBLIC DEBTS,
TOTAL AND AS A PERCENTAGE OF GDP
debt
From the end of World War II to 1960, the public debt grew only slowly, as the federal government periodically ran surplus budgets and retired old debt. However, since 1960, presidents have rarely been able to run surpluses to reduce the debt. In 1980, Ronald Reagan campaigned against President Carter on a platform to reduce public debt. At that time the debt was approaching $1 trillion. Reagan won the election and then proceeded to increase the public debt. When President Reagan left office, the debt was over $3 trillion or more than 3 times the public debt that he sought to reduce during his 1980 candidacy!

The federal government has had only five annual budget surpluses since 1960 — one in 1969 and four from 1998-2001. As a result, by the end of 2004, the public debt had grown to $7.6 trillion, over 26 times as large as it was in 1960. Subsequently, both the Bush and Obama Administrations signed laws authorizing a total of $1.4 trillion in new spending to bail out financial institutions and help workers regain jobs from the 2007-2009 downturn, so that in only 6 short years, by June 2010, the debt had almost doubled again to $13.2 trillion. See The Debt to the Penny and Who Holds It.

The public debt is composed of debt held by the public and intragovernmental holdings. Debt held by the public is all federal debt held by individuals, corporations, state or local governments, foreign governments, and other entities outside of the United States Government less Federal Financing Bank securities. Types of securities held by the public include, but are not limited to, Treasury Bills, Notes, Bonds, and TIPs, United States Savings Bonds, and State and Local Government Series securities. Treasury Bills, Notes, Bonds, and TIPs are marketable securities. United States Savings Bonds, and State and Local Government Series securities are non-marketable securities. As of mid-2010, debt held by the public was almost $8.8 trillion or 67% of the public debt. Intragovernmental Holdings are the Federal Financing Bank securities and the Government Account Series securities held by government trust funds, revolving funds, and special funds. Only a small amount of marketable securities are held by government accounts. As of mid-2010, intragovernmental agencies were $4.5 trillion or 33% of the debt.

A major concern in financing the public debt is the debt held by the public. Unlike the trust funds, the public is not obligated to buy or hold Treasury securities. The Treasury may have a very difficult time refinancing the debt, if the public chooses not to buy new issues at competitive interest rates.

A subsidiary concern is the volume of marketable debt held by foreigners. As of mid-2010, foreigners held almost $3.9 trillion of marketable debt. Foreigners buy U.S. government debt for two reasons: perceived safety and relative interest rates. The U.S. has been considered a safe haven for many years and foreigners have bought Treasury securities because they are considered to be "risk free." However, foreigners also buy and sell Treasury securities depending on how U.S. interest rates compare with interest rates in other "safe haven" countries. When U.S. rates rise relative to rates in these other countries, foreigners buy. However, when U.S. rates fall relative to rates in these other countries, foreigners sell. If the U.S. should ever lose its status as a "safe haven" (that is, if foreigners should ever lose confidence in the U.S. dollar) or if U.S. interest rates fall too low, foreigners will sell their Treasury securities and interest rates would increase very rapidly. Such an wholesale sell-off could seriously undermine monetary policy in the U.S.

In theory, the public debt is subject to a statutory debt ceiling. Congress sets the ceiling. However, when Congress passes a budget that has a deficit that requires financing beyond the ceiling, it simply passes a law raising the debt ceiling. The statutory debt ceiling as of June 2010 was $14.2 trillion. For more information on the public debt, see current issues of the Treasury Bulletin.

top    IV. Debt Management Tools

In funding the annual budget deficit or in rolling over old debt, the government has the option of issuing four types of marketable securities with different maturities: short-term bills, medium-term notes, long term bonds, or Treasury Inflation-Protected Securities (TIPS).

Short-term securities consist of T-bills in 4-week and 3- and 6-month maturities (which are sold on a regular schedule) and cash management bills (which are not sold on a regular schedule). Bills are sold at a discount from face value and the interest earned is the difference between the price paid for the bill and its face value. The minimum denomination for bills is $1,000. They are sold on both a competitive basis (generally to banks and dealers) and a non-competitive basis (generally to individuals). Non-competitive buyers receive a yield equal to an average of the weighted yields paid to the competitive bidders. For more information on bills and schedules of offerings, see Treasury Bills.

Medium-term securities consist of T-notes in 2-, 3-, 5-, 7-, and 10-year maturities. They are sold on a regular schedule. Notes are sold at or close to face value and pay interest semi-annually until maturity. Like bills, the minimum denomination for notes is $1,000, they are sold on both a competitive basis (generally to banks and dealers) and a non-competitive basis (generally to individuals), and non-competitive buyers receive a yield equal to an average of the weighted yields paid to the competitive bidders. For more information on notes and schedules of offerings, see Treasury Notes.

Long-term securities consist of T-bonds in 10-30 year maturities. The Treasury stopped issuing 20-year bonds in January 1986 and 30-year bonds in October 2001. The last of the 20-year bonds matured in 2006. The Treasury resumed offering 30-year bonds in February 2008. Bonds pay interest semi-annually until maturity. The minimum denomination for bonds is $1,000 (when issued). For more information on bonds and schedules of offerings, see Treasury Bonds.

Treasury Inflation-Protected Securities (TIPs) consist of 5-, 10-, and 20-year maturities. TIPs are designed to provide protection against inflation. The principal of a TIPs increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPs matures, the Treasury pays the adjusted principal or original face value, whichever is greater. The minimum denomination for TIPs is $1,000. They are sold on both a competitive basis (generally to banks and dealers) and a non-competitive basis (generally to individuals). For more information on TIPs and schedules of offerings, see Treasury Inflation-Protected Securities.

top    V. The Yield Curve

TERM STRUCTURE OF INTEREST RATES
AND THE YIELD CURVE
yield curve
The Term Structure of Interest Rates

The term structure of interest rates shows the relationship between the yields (rates of return) on financial instruments of comparable unsytematic risk and their maturities. The difference between long-term rates and short-term rates is a measure of risk over time.

The Yield Curve

The yield curve is a graphical representation of the term structure of interest rates. The graph to the right is a pictorial representation of the yield curve for U.S. government securities. The yield curve is often measured as the spread between a long-term interest rate and a short-term interest rate. The Conference Board uses the spread between the 10-year T-bond rate and the federal funds rate. Other researchers use the spread between the 10-year T-bond rate and the 3-month T-bill rate and the spread between the 10-year T-bond rate and the 6-month T-bill rate.

Shapes of the Yield Curve

yieldcurveshypo
Inverted yield curve: Slopes downward (C). Yields fall as maturity lengthens. Spread between long-term interest rate and short-term interest rate is negative.
Flat yield curve: Flat; no slope (B). Yields remain constant as maturity lengthens. Spread between long-term interest rate and short-term interest rate is zero.
Normal yield curve: Slopes upward (A). Yields rise as maturity lengthens. Spread between long-term interest rate and short-term interest rate is positive.

Theories of the Shape of the Yield Curve

Opportunity Cost Hypothesis

The Opportunity Cost Hypothesis is a demand-side approach, which assumes lenders have a time preference theory of consumption and that they prefer a dollar today to a dollar tomorrow. The longer the maturity on the loan, the greater the opportunity cost. Therefore, to induce lenders to lengthen the maturity on their loans, yields must be higher on longer-term maturities to compensate them for the lost opportunity of current consumption. This hypothesis does not explain inverted yield curves.

Liquidity Hypothesis

The Liquidity Hypothesis is a demand-side approach, which assumes most lenders prefer short-term liquidity to long-term return. The primary reason for this preference is that prices on short-term securities fluctuate less in response to changing interest rates than do the prices of long-term securities. If interest rates rise during the holding period and a lender has to liquidate a security before it reaches maturity, the capital loss on a short-term security will be much less than that on a long-term security. Therefore, the shorter the maturity the larger the supply of loanable funds and the lower the short-term interest rate. The longer the maturity the smaller the supply of loanable funds and the higher the long-term rate. To induce long term lending, borrowers must offer higher rates — a "liquidity premium" — to overcome the liquidity preference of lenders. This hypothesis does not explain inverted yield curves.

Uncertainty Hypothesis

The Uncertainty Hypothesis is a demand-side approach, which assumes calendar time — that the past is known, but the future is uncertain. The further one moves out in time, the more uncertainty exists. The more uncertainty, the more risk. The longer the maturity, the greater the chance that any number of events will occur that will reduce the return to the lender: the borrower might default, interest rates may rise, prices may rise, the bond may be called, tax laws may change, etc. Therefore, to induce lenders to lengthen the maturity on their loans, yields must be higher on longer-term maturities to compensate for the additional uncertainty of time. This hypothesis does not explain inverted yield curves.

Expectations Hypothesis

The Expectations Hypothesis is a market approach, which assumes financial instruments with different maturities are perfect substitutes for one another and that both borrowers and lenders are indifferent among maturities. The slope of the yield curve depends on individuals expectations of the future direction of interest rates. The yield curve will slope upward if people expect interest rates to rise; the yield curve will slope downward if people expect interest rates to fall; and the yield curve will be flat if people believe interest rates to stay the same.

The current yield to maturity for any given maturity will equal the average of the short-term interest rates lenders expect to occur over the length of the loan. For example, assume that an individual wants to save $1,000 for 2 years. The saver can either buy two 1-year bills or a 2-year note. The current 1-year bill rate is 3% and the 2-year note rate is 4% (a normal yield curve). The reason the yield curve is normal is because most lenders expect that the rate on a 1-year bill during the second year of the investment period is expected to be 5%: (3% + 5%)/2 = 4%. If lenders do expect the 1-year interest rate to be 5% next year, and the rate on 2-year notes is 4.5%, everybody will rush to buy the 2-year notes, thus raising price and depressing yield until the yield reaches 4% and the return on the 2-year note is the average of the expected rate of return from holding two 1-year bills. If the rate on 2-year notes is only 3.5%, nobody will buy the 2-year notes; everyone will opt for two 1-year bills. This dearth of buyers will depress price and raise the yield on 2-year notes until the yield reaches 4% and the average expected rate from holding two 1-year bills. The reverse would hold true if interest rates were expected to fall; that is, the yield curve would slope down (an inverted yield curve). The Expectations Hypothesis explains normal, inverted, "humped," and flat yield curves.

Segmented Markets Hypothesis

The Segmented Markets Hypothesis is a market approach, which assumes financial instruments with different maturities are not perfect substitutes, that borrowers and lenders have specific preferences for certain maturities, and that the various markets for financial instruments with different maturities are completely separated and segmented. The slope of the yield curve depends upon the number of lenders and borrowers (demand and supply) in each of the several markets segmented by maturity. For example, if most lenders prefer liquidity, the short-term markets will have more buyers relative to sellers. This imbalance will increase the prices on short-term securities and push down yields. Since fewer lenders prefer the long-term markets, prices of bonds will decrease and yields higher. By the same token, borrowers prefer to borrow long-term. This imbalance means a dearth of short-term securities, which further adds to higher prices and lower yields at the short-term end of the maturity spectrum, and a plethora of long-term securities, which further adds to lower prices and higher yields at the long-term end of the maturity spectrum.

The market segmentation hypothesis explains normal, inverted, "humped," and flat yield curves. For example, if the federal government undertook a massive financing with short-term T-bills, while the primary lenders were pension funds buying in the long-term markets. The increased supply of T-bills would tend to depress prices and raise yields in the short-term markets, while the increased demand by pension funds would tend to raise prices and depress yields in the long-term markets. Therefore, under the segmented markets hypothesis, the actual yield curve reflects the relative supply and demand for each maturity.

Preferred Habitat Hypothesis

The Preferred Habitat Hypothesis is a market approach, which assumes that financial instruments with different maturities are substitutable over a range of maturities, but not substitutable between ranges. The interest rate on any maturity financial instrument will equal the average of the short-term interest rates lenders expect to occur over the length of the loan, plus a term premium for the length of the maturity, within the range. An upward sloping yield curve reflects a small expected increase in future short-term rates. A downward-sloping curve reflects a more significant expected decline in future short-term interest rates. And, a flat yield curve reflects an expectation of slightly falling future short-term interest rates. The Preferred Habitat Hypothesis explains normal, inverted, "humped," and flat yield curves.

top    VI. Debt Management Policies

In selecting maturities for financing, the Treasury needs to consider three goals: minimizing interest costs, minimizing instability in financial markets, and promoting economic stabilization.

Minimizing Interest Costs

If the goal of the Treasury were truly to minimize interest costs, then it would simply print money to pay off all its outstanding debt and any new expenditures. Such exchange of non-interest-bearing monies for interest-bearing securities would be a form of dysfunctional finance that would result in massive inflation, and one goal of debt management is to promote economic stability. Therefore, the treasury is not allowed to finance by printing money.

Short-Term Financing Since yield curves normally slope upward, issuing T-bills is generally the most cost-efficient method for funding the public debt. It is also preferable when the government has a temporary cash flow problem for the Treasury to offer 4-week or 3-month T-bills or cash management bills, which can be paid off from tax collections. However, financing short-term when the yield curve is upward sloping means that the Treasury may have to refinance low-cost short-term issues at higher interest rates down the road, if interest rates do, in fact, rise. When the yield curve is inverted, financing short-term may raise interest expense in the short-run, but it avoids locking the Treasury into paying high long-term rates. When interest rates fall and the yield curve resorts to normal, the Treasury can substitute lower-cost long-term securities for the more costly short-term securities.

Long-Term Financing Since yield curves normally slope upward, issuing bonds is generally the most expensive method for financing the public debt. However, if the yield curve has a normal slope and interest rates are expected to rise, then it is preferable for the Treasury to finance long-term now to avoid financing at higher rates later on. If the yield curve is inverted, the cost-minimizing approach would be to refund long-term securities with short-term securities, until such time as interest rates fell and the Treasury would switch back to long-term financing.

To minimize the cost impact of long-term funding, in 1917, Congress passed the Victory Liberty Loan Acts in 1917 and 1918 limiting the coupon rate that the federal government can offer on bonds to 4.25%. While this ceiling rate limits the federal government's interest cost per bond, the net effect is to raise the federal government's interest expense, especially if market interest rates are above the congressional ceiling. If market interest rates are above the congressional ceiling, then the federal government's bonds must be sold at a discount. To raise the same amount of monies, the Treasury must increase the quantity of bonds sold, thus increasing its total interest payment and defeating the purpose of the ceiling.

With rising interest rates in the late 1960s and early 1970s, U.S. government bonds became unattractive and uncompetitive with relatively comparable securities. In 1971, Congress suspended the 4.25% ceiling rate and authorized the issuance of a limited volume ($10 billion) of bonds with maturities in excess of seven (7) years. The Treasury soon exhausted its authority and Congress had to repeat enactment of the authorizations. Finally, in 1988, recognizing the realities of the market, Congress eliminated the ceiling rate on marketable bonds altogether.

Minimizing Instability in Financial Markets

Short-Term Financing Yield curves normally slope upward. However, if the Treasury were to engage extensively in short-term financing to minimize interest costs, its borrowing of such substantial monies every couple of weeks would create a mismatch of lenders and borrowers in the short-term markets and would have the effect of inverting the yield curve. High short-term rates tend to discourage inventory accumulation, thus creating shortages and bottlenecks in the production process.

Additionally, the current marketable public debt is about $8.8 trillion. If the Treasury were to issue only 3-month T-bills to minimize interest costs, and did so once each week (just to rollover the old debt, not to finance new debt), the government would, on average, be borrowing $733 billion each week. Such a large sum would have substantial destabilizing effects on the financial markets, for all other borrowers would be crowded out once a week.

Long-Term Financing Since yield curves are normally upward-sloping, long-term financing is more expensive. However, it tends to be less destabilizing to long-term markets. If the Treasury spreads the $8.8 trillion into smaller monthly offerings of 30-year bonds (again, assuming only rollover, no new debt), it is in the market less frequently and is borrowing only $24 billion each month. Since its borrowing is smoothed out over time, each entry into the markets requires fewer lenders and thus makes room for more private sector borrowers. If, however, the Treasury were to engage only in long-term borrowing, and since it is the single largest borrower in the country, this excess supply of long term bonds would have the tendency to exaggerate the upward slope of a normal yield curve. Steep normal yield curves with high long-term rates discourage long-term financing for capital formation and tend to signal increases in the inflation rate.

Promoting Economic Stabilization

Short-Term Financing During a recession, interest rates are generally low because demand for financing by the private sector is low. If the government tries to minimize interest costs by issuing long-term securities, it will tend to push up long-term interest rates and steepen the slope of the normal yield curve. However, the last thing the government wants to do in a recession is to push up long-term rates, because high long-term rates have the effect of reducing consumer durables, residential housing, and business capital expenditures. Therefore, stabilizing economic activity during a recession calls for short-term financing by the Treasury, even though it may have to refinance at higher rates after the recovery.

Long-Term Financing During a boom period, the government wants to see long-term rates rise to choke off inflationary private sector spending. Therefore, prosperous periods call for the Treasury to stabilize economic activity and take inflationary pressures out of the economy by financing with long-term issues. However, this locks the government into high long-term rates and excessive interest expense long after the economy has cooled.

The Trade-Offs

Obviously, trade-offs exist (1) between short-term financing to "pump-prime" the economy in a recession and long-term financing to promote financial market stability and (2) between short-term financing to minimize interest costs and long-term financing to reducing inflationary pressures. The Treasury must, therefore, perform a fine balancing act in staggering the maturity of its issues to achieve all goals simultaneously.

top    VII. Debt Management Practices

The Treasury is the single largest borrower in the financial markets. Obviously, its choice of maturity instruments to fund the public debt has a significant impact on the term structure of interest rates and, thus, on the shape of the yield curve. By varying the maturities that it offers, it can create mismatches in supply and demand along the maturity spectrum and thus influence the course of aggregate economic activity by changing the term structure of interest rates.

Of the $13.2 trillion in public debt, about 33% or $4.4 trillion is in non-marketable form. Non-marketable securities include securities held by various government trust funds, U.S. savings bonds, special foreign issues, and special state and local government issues. That leaves approximately $8.8 trillion in marketable debt that is funded through the financial markets.

To keep this funding manageable and to prepare properly the financial markets for Treasury financing operations, the Treasury has pre-scheduled auctions for certain securities with specific maturities. See also Treasury Auctions and Auction Rules.

Treasury Bills New supplies of 3-month and 6-month T-bills are auctioned weekly on Mondays and new supplies of 4-week T-bills are auctioned weekly on Tuesdays. Cash management bills are issued on a "when needed" basis.

Treasury Notes The 2-year notes are offered each month about one week before the end of each month. The 5-year notes are offered each month on the 15th of the month. The 3- and 10-year notes are issued during the second month of each quarter (February, May, August, and November) on the 15th of the month.

Treasury Bonds The Treasury suspended its offering of 30-year bonds from 2002 to 2006 and now offers them once a month on the second Thursday.

TIPs The 5-year TIPs are offered in April (with a reopening in October) on the 15th of month. The 10-year TIPs are offered in January and July (with reopenings in April and October, respectively) on the 15th of month. The 20-year TIPs are offered in January (with a reopening in July) on the 15th of month.

The interest coupon constraint on long-term bonds forced the Treasury to resort mostly to bill and note issues. As a result, the average maturity on outstanding debt has declined substantially since the end of World War II. The average maturity has fallen to about 5.0 years from 7.5 years following the war. The average reached a nadir of 2 years 5 months maturity in 1975. In 1950, 40% of marketable debt had a maturity over 5 years. By 1987, just over 25% had a maturity over 5 years. About 1/3 of all debt must be rolled over each year.

Rolling over the debt poses three serious problems for financial and economic markets. First, the shorter average maturity reduces the time between offerings and forces the Treasury into the financial markets more frequently. Continual short-term financing can have substantial destabilizing and crowding out effects. Second, to ensure a modicum of success, the Federal Reserve must mitigate its own monetary posture to supply sufficient liquidity to prevent destabilization and crowding out in the financial markets. This intervention may mean an overly expansionary policy at a time when restraint is necessary. Finally, short-term T-bills are held by commercial banks and other lending institutions as secondary liquidity. To the extent that an excess supply of near-liquid assets exists, commercial banks and other lending institutions can divest their holdings of T-bills rather easily to extend more credit. This liquidation can be inflationary.

top     Summary

Debt management policy must be administered in coordination with monetary and fiscal policies. If the goal of debt management is to minimize interest costs, and the Treasury has a massive amount of new debt to fund or old debt to roll over, then monetary policy must be more accommodative, even if the objective of current monetary policies is restriction. Monetary policy is generally most restrictive during boom periods, at which point, accommodation by the monetary authority might aggravate inflationary pressures. If the goal of debt management is to promote economic stability during a recession, then the monetary authority must be prepared to change the forcefulness of its own actions to avoid offsetting the effects of Treasury financing on interest rates. Otherwise, the cost of financing to the Treasury may rise.

Given the continuing magnitude and frequency of Treasury financing operations, coordination between the monetary and debt management authorities is essential. While debt management policies have generally been considered the "runt" of economic stabilization policies (monetary, fiscal, and debt management policies), no amount of rhetoric can underscore the importance of successful continuation of refinancing such a large volume of government securities without unduly disturbing the nation's financial markets and its economic stability. Without a continuous record of successful Treasury refinancings, the federal government would not be able to engage in deficit financing for economic stabilization purposes.

top    Readings

Treasury Debt Instruments

Treasury Securities at a Glance, Treasury Dept., Bureau of the Public Debt

Bartolini, Leonardo and Carlo Cottarelli, Designing Effective Auctions for Treasury Securities, Current Issues in Economics and Finance (FRBNY). 3(9) Jul 1997

Culbertson, John M. "The Term Structure of Interest Rates," Quarterly Journal of Economics. LXXI Nov 1957: 485-517

Dueker, Michael. Strengthening the Case for the Yield Curve as a Predictor of U.S. Recessions, Review (FRBStL). 79(2) Mar/Apr 1997

Estrella, Arturo and Frederic S. Mishkin, The Yield Curve as a Predictor of U.S. Recessions, Current Issues in Economics and Finance (FRBNY). 2(7) Jun 1996

Fedpoint #5: Book-Entry Procedure, FRBNY

Fedpoint #28: Estimating Yields on Treasury Securities. FRBNY

Fedpoint #41: Treasury Auctions, FRBNY

Feiler, Keith, updated by Tim Schilling. Public Debt: Private Asset. FRBChi. 1998

Gokhale, Jagadeesh, Generational Equity and Sustainability in U.S. Fiscal Policy, Economic Commentary (FRBClev). 15 Apr 1998

Hamburger, Michael and William L. Silber. "Debt Management and Interest Rates: A Re-examination of the Evidence," The Manchester School of Economic and Social Studies. XXXIX Dec 1971: 261-67

Haubrich, Joseph G. and Ann M. Dombrosky. Predicting Real Growth Using the Yield Curve, Economic Review (FRBClev). 32(1) 1Q96

How Marketable Securities Really Work, Treasury Dept., Bureau of the Public Debt

Jordan, Jerry, Interest Rates and Monetary Growth, Review (FRBStL), Jan 1973

Kangas, Steve. Budgets and Deficits, Lang, Richard W. and Robert H. Rasche. "Debt Management Policy and the Own-Price Elasticity of Demand for U.S. Government Notes and Bonds," Review (FRBStL). Sep 1977: 8-22

Modigliano, Franco and Richard Sutch. "Innovations in Interest Rate Policy," American Economic Review. LVI(2) May 1966: 178-97

__________. "Debt Management and the Term Structure of Interest Rates: An Empirical Analysis of Recent Experience," Journal of Political Economy. LXXV Aug 1967: 569-89

Okun, Arthur M. "Monetary Policy, Debt Management, and Interest Rates: A Quantitative Appraisal," in Commission on Money and Credit, Fiscal and Debt Management Policies. Englewood Cliffs, NJ: Prentice-Hall, 1963: 331-80

Pierson, Gail. "Effect of Economic Policy on the Term Structure of Interest Rates," Review of Economics and Statistics. LII Feb 1970: 1-11

Roley, V. Vance. "A Theory of Federal Debt Management," American Economic Review. LXIX(5) Dec 1979: 915-25

__________. "Federal Debt Management Policy: A Re-examination of the Issues," Economic Review (FRBKC). Feb 1978: 14-23. Reprinted in Financial Institutions and Markets in a Changing World. Donald R. Fraser and Peter S. Rose, eds. Dallas: Business Publications, 1980: 439-50

__________. "The Financing of Federal Deficits: An Analysis of Crowding Out," Economic Review (FRBKC). Jul/Aug 1981: 16-29

Rolph, Earl R. "Principles of Debt Management," American Economic Review. XLVII Jun 1957: 302-20

Rudebusch, Glenn. Interest Rates and Monetary Policy, FRBSF Economic Letter. 97(18) 13 Jun 1997

Scott, Robert Haney. "Liquidity and the Term Structure of Interest Rates," Quarterly Journal of Economics. LXXIX Feb 1965: 135-4.

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Stevenson, Richard W. Three Decades of Red Ink, New York Times. 1 Oct 1998

__________. The Deficit's Gone, but Not the National Debt, New York Times. 31 Jan 1999

Treasury Bill and 2-Year Note Minimums Cut to $1,000. Department of the Treasury. 5 Aug 1998

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Vice President Gore Introduces New Inflation-Indexed Savings Bonds. Department of the Treasury. 8 Jul 1998

top    Websites

Treasury Direct, Treasury Dept.
Bureau of the Public Debt, Treasury Dept.
Treasury Bulletin, Treasury Dept.
A History of the U.S. Debt Ceiling Since 1940. The Privateer. Tables and charts.


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