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Debt Maturity: Is Long-Term Debt Optimal?

Prior to many of the major emerging market financial crises of the past decade Mexico, Russia, Brazil, Argentina governments borrowed large amounts of short maturity liabilities. Each of these countries subsequently had to roll over large amounts of short-term debt to meet its payment obligations. Scholars have argued that short-term liabilities render an economy particularly vulnerable as the shorter and more concentrated the debt maturity the more likely debt crises are to occur. In addition, short term debt may increase a country's exposure to sharp increases in interest rates, which may have additional negative consequences, as governments may need to increase taxes in order to service the debt.

Reacting to the apparent link between the maturity structure of government debt and these financial crises, many academics and policy makers have urged governments to increase the maturity of the debt. However, governments usually have to pay a higher premium on long-term bonds, a premium that may reflect uncertainties about governments ability (including issues of taxation and inflation) but also willingness to repay.

The short-term maturity structure of emerging market debt simply might be a market response to deeper problems associated with uncertainty and enforcement of contracts. Hence, at least from a theoretical point of view, it is not clear that the optimal maturity of government debt is characterized by large quantities of long-term debt.

In this paper, we quantitatively compare the different rationales in favor of and against short-term debt in order to evaluate the optimal debt maturity of a government. Those rationales broadly include: maturity premium , sustainability, and service smoothing. We do this by modeling the different arguments and calibrating the model in order to assess their quantitative importance.

Debt Maturity: Is Long-Term Debt Optimal?