No. 278 - Real Interest Rates, Sovereign Risk and Optimal Debt Management

by Francesco Drudi and Raffaella Giordano
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The role of movements in real rates in explaining the relationship between long and short-term interest rates is explored using a model of optimal government debt management. The government's incentives to resort in the future to inflation and ex-post debt taxation in order to reduce the real value of its nominal liabilities have an impact on term premia and hence on the short-long spread. Inflation risk and default risk are perceived to be higher the larger the stock of outstanding debt. A policy of lengthening the maturity of debt may reduce the risk of default, while indexed bonds may increase it.

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  1. 30 September 1996
    No. 278 - Real Interest Rates, Sovereign Risk and Optimal Debt Management
    PDF 9 MB