Debt management when monetary and fiscal policies clash: some empirical evidence

Abstract

We explore the effects of fiscal and monetary policy shocks on key debt management variables and provide empirical evidence supporting the notion of a strict separation of economic policy from the debt management agenda. We find that a tighter monetary policy coupled with fiscal expansion increases the risk that government debt will have to be rolled over at unusually high cost. This is especially the case in a downturn, where low or even negative interest rates often provide incentives for debt managers to invest predominantly in short-term bonds. Our findings echo the post-crisis environment of low or even negative interest rates, where many debt managers altered their portfolios' structure in favor of short-term bonds. In this respect, we argue that debt managers should use a longer optimization horizon and base their strategy on the medium- and long-term economic outlook.